Who would have thought that white-boy hip-hop could hold a mirror up to the financial markets…no, not me either. Firstly, we’ve got the Beastie Boys fighting for the right to a (central) counterparty and then InterContinentalExchange (ICE) leading the chorus of Vanilla Ice’s 90s anthem "Ice Ice Baby". Post-Lehmans ("PL" – that’s right we’re coining a new acronym right here, right now) the concept of counterparty risk came to the fore – it always existed, it’s just that people didn’t really expect giant banking institutions to fail.
Not for the first time, the market was spectacularly wrong. Either way, the successful transfer of trades PL overcame a major hurdle in the clean-up operation and marked the clearing and settlement operations that underpin many markets as one of the few success stories of last year. This was not only true of equities but also the centrally cleared futures and OTC interest rate swaps, which were swiftly reallocated without loss to counterparties and without disruption. On the other hand, Lehman’s unregulated credit default swaps and non-cleared interest rate swaps brought chaos to the market. The case for centralised clearing and the danger of defaulting counterparties was duly presented and the debate has rumbled on behind the scenes ever since.
Now, counterparty risk and centralised clearing have again been cast centre stage, with moves afoot on Capitol Hill to institute sweeping changes to the structure and regulation of the massive OTC derivatives business. Citadel’s influential CEO Kenneth Griffin has been quick to weigh into the debate and called for the overturn of the ‘merchants of status quo’ and the worth of the centralised clearing model. Granted, his motives are probably not entirely altruistic – after all, this is the same Citadel that has a joint venture with the CME to clear credit. Self-interest aside, clearing is definitely back on everyone’s lips – from exchanges to regulators to banks to hedge funds.
ICE, the futures exchange group, has been swift to react to the new world order and forged ahead in the race to clear credit default swaps. The group announced yesterday that nearly all new CDS contracts would be cleared centrally by the end of the month. This is impressive stuff and as Hal Weitzman writes in today’s FT: "ICE has taken a strong lead amongst exchanges". This is probably a wise decision and as Jeremy Grant relayed earlier in the week: "governments and regulators in the US and Europe have made wider use of clearing – particularly in the over-the-counter derivatives market – a pillar of reform of financial markets." ICE has stolen a march on their competitors and given their relationships and collaboration with the main CDS dealers has reportedly cleared more than 43,000 index trades in Europe and the US with a notional value of more than $3,5000bn.
This is a big, lucrative market and Jeff Sprecher, ICE’s chief executive, has been in an understandably buoyant mood of late. Does this signal a return to confidence in the credit derivatives market? Perhaps so…in which case – ICE ICE Baby indeed.