Banks launch central clearer for derivatives

By Hal Weitzman
Financial Times, London
Wednesday, May 28, 2008

http://www.ft.com/cms/s/0/add2f5e6-2cdd-11dd-88c6-000077b07658.html?ncli...

CHICAGO -- Efforts to tackle the risk surrounding privately negotiated credit derivatives will take a step forward on Thursday when 11 of the world's biggest investment banks announce the creation of the first central clearer for the opaque contracts by September.

The absence of a central clearer has made such contracts risky because there is no guarantee that parties will pay out.

This systemic risk has fuelled the global credit crunch, prompting regulators to step up pressure on banks to show they are trying to make the system more dependable.

Credit derivatives allow investors to make bets on the creditworthiness of baskets of corporate debt. Global growth in the notional value of such contracts grew by 81 per cent last year to a value of $62,200 billion.

Credit derivatives contracts are predominantly negotiated privately between traders who rely on their assessments of each other’s ability to pay under the terms of the contract. A clearer uses funds contributed by traders to guarantee against default.

"The credit crisis has definitely heightened interest in this kind of solution among the regulators," said Kevin McClear, chief operating officer of The Clearing Corporation, the Chicago-based institution backed by the banks that will act as the new clearer. "We don't think there's a better approach to reducing systemic risk."

The need to act fast to pre-empt stiffer regulation in the wake of the credit crisis has given impetus to a proposal that has been 18 months in the making. It has also been accelerated by attempts by other clearers, such as LCH.Clearnet, Europe's largest independent clearer, and the CME Group, the Chicago-based derivatives exchange, to muscle in on the business potential of clearing such over-the-counter derivatives.

Thursday's proposal is the result of an agreement between The Clearing Corporation (also known as CCorp) and the Depository Trust and Clearing Corporation (DTCC), the New York-based clearing group.

CCorp's backers -- including Goldman Sachs, Citigroup, JPMorgan, Bear Stearns and Morgan Stanley -- will establish a guarantee fund to cover losses if any firm should fail.

While Thursday's announcement is sure to be welcomed, questions remain about whether the proposal will raise industry standards or if it is largely cosmetic.

* * *