March 5 (Bloomberg) -- Intercontinental Exchange Inc.’s bid to become the top U.S. guarantor of credit-default swap trades moved a step closer after the Federal Reserve approved its proposal, leaving the Securities and Exchange Commission as the futures market’s final regulatory hurdle.

Intercontinental and larger rival CME Group Inc. are among four clearinghouse owners vying to back the $27 trillion credit- default swap market, with as much as $400 million a year in revenue up for grabs, according to estimates by Keefe Bruyette & Woods Inc.

“I don’t think the SEC will have any issues” signing off Intercontinental’s clearing plans after the Fed approved them yesterday, said Brian Yelvington, an analyst at CreditSights Inc. in New York. “I hope it’s a rubber stamp, because given the new regulatory regime I would hope this has been a carefully coordinated process.”

Regulators on both sides of the Atlantic are developing separate plans to stabilize the derivatives market after American International Group Inc., once the world’s largest insurer, almost went bankrupt last year from its use of credit-default swaps. The unregulated, privately traded contracts stymied government efforts to assess bank credit risk because the full range of trades between dealers was unknown.

SEC spokesman John Nester said he didn’t know when the agency will make a decision. “The proposal is under active consideration,” he said in an interview yesterday.

Sharing Powers

The Commodity Futures Trading Commission, Federal Reserve Board and SEC signed a memorandum of understanding in November to share regulatory information. Under the plan, the CFTC would oversee the CME Group effort, the Fed would oversee the Intercontinental proposal and the SEC would reserve the right to regulate clearing at a later date.

The CFTC granted CME Group the go-ahead for credit-default swap clearing on Dec. 23. Intercontinental’s plan has the backing of eight major dealers including JPMorgan Chase & Co. and UBS AG.

One issue holding up the Intercontinental approval process was designing a system to price credit-default swaps that trade infrequently. This so-called marking to market has likely been solved, though it hasn’t been made public, BMO Capital Markets analyst Mike Vinciquerra wrote in a note to clients today.

A clearinghouse acts as the buyer to every seller and seller to every buyer, reducing the risk of a counterparty defaulting on a transaction. In the over-the-counter market, where credit- default swaps are currently traded, participants are exposed to each other in case of a default. A clearinghouse also provides one location for regulators to view traders’ positions and prices.

Credibility

“For the Fed it’s a great step,” said Mark Williams, a finance professor at Boston University. “It’s another brick to rebuild credibility in the credit markets so we don’t have a future AIG.”

Credit-default swap trades made by AIG caused the U.S. government to rescue the insurer with at least a $150 billion bailout package. New York-based AIG’s troubled trades were largely linked to hard-to-value mortgage debt securities, rather than the actively traded contracts that are likely to be backed by clearinghouses.

Regulators also became concerned about stability in the market when Lehman Brothers Holdings Inc., one of the largest dealers in credit-default swaps, was allowed to go bankrupt in September. The failure of Lehman left its trading partners with hundreds of millions of dollars in losses, according to Moody’s Investors Service.

NYSE Clearing

The SEC is being asked by Intercontinental and CME Group to grant exemptions from rules that would have prevented them from processing the securities. The exemptions give the regulator time to review the exchanges’ business to determine whether to make the exemptions permanent.

Intercontinental spokeswoman Sarah Stashak and CME Group spokesman Allan Schoenberg declined to comment on when the companies may receive SEC approval.

Other proposals to clear credit-default swaps have been made by NYSE Euronext, Eurex AG and LCH.Clearnet Ltd. Only the NYSE effort is available now for clearing after starting on Dec. 22. As of Jan. 30, no swaps had been cleared by the NYSE’s London- based derivatives exchange, according to NYSE CEO Duncan Niederauer.

Credit-default swaps are derivatives used to hedge against losses or to speculate on the ability of companies to repay their debt. The contracts pay the buyer face value in exchange for the underlying securities if a borrower fails to adhere to its debt agreements.

Member Worth

Members of the Intercontinental clearinghouse will have to have a net worth of at least $5 billion and a credit rating of A or better to clear their credit-default swap trades, the Fed said in its approval yesterday. Each clearing member will have to contribute at least $20 million to a guarantee fund, which is used in case of a trader default.

Intercontinental Chief Executive Officer Jeff Sprecher has said he eventually wants the guarantee fund to be in the range of $1 billion.

The Fed decision came two days after the Federal Trade Commission and the Justice Department granted approval to Intercontinental to buy Clearing Corp., a Chicago-based clearinghouse owned by eight major dealers in the credit-default swap market. That deal gives Intercontinental the support of the market’s largest users.

This partnership “should help to improve odds of success” for Intercontinental, Howard Chen, an analyst with Credit Suisse, said in a note to clients today. Still, he said the banks would likely spread their business around to other clearinghouses in the early stages until a winner emerges.

Intercontinental said yesterday that it expects to close the Clearing Corp. purchase within a week. The terms of the acquisition haven’t been disclosed.

To contact the reporter on this story: Matthew Leising in New York at mleising@bloomberg.net

Last Updated: March 5, 2009 09:28 EST