MCC280

America Needs an Independent Clearinghouse for OTC, CDS

Jeff,

I would like to thank you and Paul for a well contrived article that covers the need of a GENUINE third party clearer in these markets, such as CME. Anyone that reads the Peterfly article needs to know that he has a well noted general disdain for CDS and anything OTC, he stands to gain nothing from the CME venture so naturally he will be opposed. The risk system his company, Interactive Brokers, developed is limited to standardized exchange traded products only, I suspect he will get pressure from customers that want to use these products and may lose them if he denies use. He also hates Citadel, they directly compete in options market making and Citadel does double the business IBKR does. He is a straight arrow and unlike other major firms, IBKR does not extend “special” credit to hedge funds via offshore “credit facilities” or by doing OTC derivatives trades or swaps with hedge fund customers as counterparties. As it stands in an industry that is losing customers in general, he can't afford to lose customers if he further limits has product offerings.

CME rolled out SPAN in 1988 and it has become the standard for risk analysis for the entire industry. In terms of clearing and risk management, nobody does it better than CME. Interesting little fact here, even The Clearing Corp uses SPAN. SPAN analyzes calculates risk using scenarios that take into account individual and broad market situations and assesses necessary margins. CME is a genuine 3rd party regulator has interest in protecting itself from risk, the banks will control The Clearing Corp and required margin under the guise of ICE as a "3rd party".

Sticking Issues with Credit Default Swaps

That seems to be the point of the exchange clearing model, $1.6 trillion is huge margin to put up but it represents a responsible amount of good faith money to make these trades. I think what it will do is turn swaps into the risk management devices they were intended to be, meaning swaps trading will become less about proprietary trading and more about a means managing risk. The scale of this market is way too large as it is in my opinion, bringing transparency will provide real mark to market valuations that will in turn give people a picture of the real default probability of a company via the transparent and aggregate opinion from all market participants. Perhaps if you see the real price of default protection through a transparent market you might not feel the need to hedge with CDS's? The margin requirements are justified, as it is to write a swap you need no capital to back it and I think the margins will prevent people from taking undue risks for profit because with margins you can't take the risk without the capital to initiate the trade. The flip side to this is that it forces banks and dealers invent another derivative our source of bankruptcy "protection" on their own terms. Now I'm only a fresh-faced 23 year old, so to call my self a novice in terms of this stuff would be a very generous evaluation of my knowledge. Although it seems that the people dealing with these swaps didn't understand them either. Purely opinion and any thoughts, criticism, or more information would be appreciated.


On Oct 29 11:01 AM nickgogerty wrote:

> Just a thought experiment, but if all CDSs were put on a centralized
> exchange today even considering the notional amounts outstanding
> netted down to 10% of the $62 trillion figure that roughly $6.2 trillion,
> assuming an average of lets 25% of that for the average margins one
> still ends up with $1.6trillion in margin required that is still
> a lot of change to come up with.