ICE Trust -- the CDS clearinghouse that the dealer banks are backing -- has finally received approval from the Fed to become a member of the Federal Reserve System. The Fed's order approving ICE Trust's application is here. My comments are below, but here are the highlights:
Initially, ICE Trust proposes to clear only contracts that are based on certain CDX North American indices and are submitted by the participants as principals. ... ICE Trust proposes to charge a fee for its CDS clearing services to participants primarily on a per-transaction basis. ... In assessing the adequacy of ICE Trust’s capital levels, the Board has taken into account the financial resources maintained by ICE Trust to enable it to withstand a default in extreme but plausible market conditions by the participant to which it has the largest exposure. ... To limit the risk of default by participants, ICE Trust proposes to establish strong and objective participant eligibility requirements. For example, only a firm with a net worth of $5 billion or more and a credit rating of “A” or better may become a participant. Among other criteria, each prospective participant also would be required to demonstrate that it has systems, management, and risk-management expertise with respect to CDS transactions. ... In addition to margin requirements, ICE Trust would require each participant to contribute a minimum of $20 million to the guaranty fund plus additional amounts based on the participant’s expected level of position exposures. Additional contributions would be assessed at least quarterly. ... To manage concentration risk, ICE Trust will charge additional margin collateral for positions exceeding pre-set notional thresholds. ... ICE Trust would promote greater market transparency by making publicly available the closing settlement price and related volume and open interest data for each cleared product, on terms that are fair, reasonable, and not unreasonably discriminatory.The first thing to note is that, at least at the outset, ICE Trust will only clear CDX indexes, and even then only contracts in which a participant (i.e., the dealer banks) are principals. Once the dealers novate all their CDX contracts to the clearinghouse, then ICE Trust will probably start clearing non-participants' CDX contracts and single-name CDS on the CDX constituents. I'm not wild about the capital adequacy being designed only to withstand "a default in extreme but plausible market conditions by the participant to which it has the largest exposure." Usually a clearinghouse's capital has to be sufficient to withstand a simultaneous default by two participants (usually the largest two participants). The fact that the test for ICE Trust's capital adequacy has been relaxed significantly is troubling. I'll have more to say later, but for now, my flight is boarding.