Photographer: John Taggart/Bloomberg

ICE to Let Investors Bypass Banks in Credit-Swaps Trading

Intercontinental Exchange Inc. is making it easier for investors looking to hedge default risks to bypass the Wall Street banks that have long been the gatekeepers in the $12 trillion credit derivatives market.

The Atlanta-based exchange owner last week debuted a new way to buy and sell contracts tied to the borrowings of individual companies, mimicking how stocks and futures are traded, according to people with knowledge of the matter. ICE is able to cut out the dealers that created the swaps market by allowing investment firms to transact with each other on the platform with a clearinghouse sitting in the middle of every trade, the people said, asking not to be identified as they are not authorized to speak publicly.

Kelly Loeffler, a spokeswoman for ICE, declined to comment on the introduction of the platform.

Shrinking Market

The move marks another shift in the credit derivatives market away from bank dealers who have traditionally acted as custodians. The new platform follows a broader industry effort to adopt central-clearing of the single-name swaps in a bid to revive the shrinking market.

The trading system comes to a market some banks have abandoned or retreated from in recent years and at a time when investors are bracing for a pickup in default rates that could revive the appeal of hedging debt holdings with the use of the insurance-like contracts. This is ICE’s second attempt to offer such a platform for trading single-name swaps, following an abandoned 2014 effort.  

Bloomberg LP, the parent company of Bloomberg News, competes with ICE and others in offering credit-default swaps trading. 

The use of clearinghouses was made mandatory for the majority of the market through the Dodd-Frank Act of 2010 in order to lessen the effects of a default on the broader market. Before that, the risk and responsibility of payment for most swaps trades was carried on the books of the investors and banks involved. That proved disastrous during the 2008 financial crisis.

Upfront Money

Clearinghouses require upfront money that’s set aside in case of default and mark positions daily to ensure risk doesn’t build. This allows ICE to now offer two hedge funds the chance to trade with each other because the firms don’t have to worry that their counter-party will go bankrupt. The clearinghouse, which is capitalized by its largest bank and brokerage members, is now the counter-party for each of the hedge funds.

Traders who enter orders into the ICE system will have the option of revealing their identity to their counter-party after the transaction is complete, in a practice known as name give-up, according to a person familiar with the matter who wasn’t authorized to speak publicly about it. The practice is common in the rest of the swaps market, and a novelty for a system that is ostensibly set up to be anonymous and automatically backed by a clearinghouse.

The purpose of the name give-up option is to try to unify banks and investors on the ICE system, the person said. In the rest of the swaps market, swap execution facilities either offer only bank-to-bank or bank-to-customer trading.

Even as cleared trading of credit-default swaps indexes has been made mandatory, there is still no regulatory compulsion to do the same with single-name swaps. BlackRock Inc., Pacific Investment Management Co. and BlueMountain Capital Management were among a group of investment firms that announced plans to voluntarily clear single-name credit-default swaps in December. The money managers are trying to bring in new participants and boost liquidity in the market.

The amount of outstanding single-name credit derivatives dropped to $6.3 trillion for the week ending July 8, from more than $33 trillion in 2008, according to data from Depository Trust & Clearing Corp.

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