CME Group, the parent of the Chicago Mercantile Exchange, and hedge fund manager Citadel Investment Group have announced plans to launch what would be the first electronic trading platform
CME Group, the parent of the Chicago Mercantile Exchange, and hedge fund manager Citadel Investment Group have announced plans to launch what would be the first electronic trading platform fully integrated with a central counterparty clearing facility for credit default swaps.
The companies believe that the joint venture, which is envisaged to launch within the next month, will help to reduce the systemic risk inherent in the vast volume of outstanding credit default swaps, which some experts believe could lead to a chain reaction of defaults. The launch of trading is subject to definitive agreement and regulatory approval.
‘Recent market events highlight the urgent need to reduce counterparty credit risks in the CDS market as well as other over-the-counter markets,’ says CME chief executive Craig Donohue.
‘Our partnership with Citadel, and our invitation to leading market participants to join this first-ever integrated solution, is a key turning point in improving the functioning of these important markets.
‘This platform provides an important opportunity for market participants to demonstrate to customers and regulators alike how these markets can be better organised to meet legitimate hedging and trading needs while reducing operational and credit risks that have grown unchecked in the OTC market.’
The proposed platform would operate as an electronic exchange that would allow the anonymous trading of credit default swaps, bets on the likelihood of default buy companies on their bonds and loans, and CDS indices, with CME Clearing, the world’s largest derivatives clearing house, acting as a central counterparty to guarantee trades.
The venture will operate as an independent organisation with its own board of directors and management team. CME and Citadel say they have invited major CDS market participants to join as founding members by allocating up to 30 percent of the equity in the venture, with certain market-maker privileges.
The incentives aim to encourage participants to migrate existing positions and to trade new CDS contracts on the platform. Acces is open to all qualified commercial market participants.
The partners say that as a fully integrated trading and clearing platform, the venture will provide market participants with enhanced liquidity through standardised contracts with fixed coupons for all leading CDS indices and their underlying single-name components, with OTC market conventions, including credit event procedures.
It will also offer facilities to convert existing bilateral trades to standardised contracts and straight-through processing into CME Clearing, reducing bilateral credit risks, outstanding notional balances and capital requirements while providing more flexibility for trading in and out of existing positions.
The joint venture has entered into preliminary licensing discussions with Markit, the financial information services company that owns the widely-traded iTraxx CDS indices and Markit RED, the industry-standard CDS identifiers.
‘In today’s environment, effective risk management is more important than ever as investors seek transparent, secure and liquid market alternatives, particularly for credit default swaps,’ says CME Group executive chairman Terry Duffy
‘Combining Citadel’s CDS technology with the safety and soundness of CME Clearing, this joint venture is a solution that will reduce much of the systematic risk inherent in the current CDS market structure.’
Citadel founder and chief executive Ken Griffin adds: ‘It is imperative to bring stability and transparency to the CDS market. This venture is a comprehensive, state-of-the-art solution that addresses today’s immediate concerns and provides tremendous opportunity for market users into the future.
