StanCollender'sCapitalGainsandGames Washington, Wall Street and Everything in Between

Take Some Risk out of Credit Derivatives

08 Oct 2008
Posted by Andrew Samwick

It will be interesting if it happens.  From FINalternatives:

Hedge fund giant Citadel Investment Group is teaming up with the Chicago Mercantile Exchange to launch an electronic credit derivatives market with a central counterparty clearing facility.

The joint venture between Citadel and the CME Group, both based in Chicago, comes ahead of the debut of a central clearing house for credit default swaps planned by The Clearing Corporation. The Federal Reserve met with industry participants in New York yesterday to discuss a central clearing facility.

“It is imperative to bring stability and transparency to the CDS market,” Citadel CEO Kenneth Griffin said. The Citadel-CME venture will “reduce much of the systematic risk inherent in the current CDS market structure.”

The marketplace and clearing house is expected to launch within 30 days. Citadel and the CME have invited banks and hedge funds to become founding members of the exchange, offering equity stakes in it of as much as 30%.

We'll get ourselves out of the mess when people see value in establishing better institutions.  Bad money drives out good.  Central clearing facilities help prevent that from happening ... next time.

Clearing house?

Could you explain the role of such a clearinghouse? That is, how do they function exactly and for what purpose?

(Explain it to me like I'm 6 years old.)

What do Clearing Houses Do?

Investopedia actually has a good description here.

The key point, I think, is that financial institutions choose to be members of the exchange.  The transparency of the exchange -- everyone trading there has agreed to abide by the same rules about settling up daily and posting enough funds to ensure that they will make payment -- makes it a more effective place to locate the trades.

Uh, that one has been in the works for a long time...

...and I'll be surprised if it's the only one you see. (Swapswire has been about for a few years now, after all.)

Clearing the trade, though, doesn't mean managing the subsequent risk.

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