ICE Trust and CDS swaps
Created in its current form in 2009, this institution has become the central clearinghouse for CDS swaps. Just about everyone has favored the clearinghouse reform, but the more I read the more I find the course of affairs to be slightly unsettling:
1. The major banks play a strong role in ownership and governance of ICE Trust. There's nothing necessarily wrong with that, but does the clearinghouse have the incentive to check excess risk-taking behavior and demand adequate collateral? (The clearinghouse does seem to have optimal incentives when it comes to netting.) And might the clearinghouse might help banks "game" the new regulatory system? Keep in mind these same banks were not disciplining each other adequately as creditors, so why should they adopt a more socially optimal set of dealings through a clearinghouse?
2. As of the spring, ICE had a market capitalization of $9 billion; relative to the size of the outstanding exposures in the CDS market, is that a lot or a little? Remember that the A.I.G. bailout had an upfront cost of about $70 billion. Is it possible that the Fed still ends up holding the bag here? In fairness, note that both clearinghouse regulation, and CFTC/SEC regulation of the clearinghouse, may help prevent such a recurrence. Better netting and position limits may go a long way.
3. "Robert Litan, an economist at the Brookings Institution, says he worries that the broker-dealer members could use ICE Trust to “blunt the competition” from competing clearinghouses and will keep it a dealers-only club with high margin requirements. ICE Trust currently requires all clearing members to have at least $5 billion in capital to join.
Another concern is ICE Trust’s 11-member board of directors, of which five members are either ICE managers or are broker-dealer representatives. Litan says ICE Trust should have a wholly independent board of directors. In a recent interview with the Center, Litan said he hopes that regulators, under the financial reform bill will begin to push for the governance issues he has championed, Litan said." Source here.
4. "Darrell Duffie, a professor of finance at the Stanford Graduate School of Business, and a member of the Financial Advisory Roundtable of the New York Federal Reserve, supports using a clearinghouse for credit default swaps. But he cautions that segregating the CDS market from the rest of the $500 trillion market for over-the-counter (off-exchange) derivatives runs counter to the risk-reducing purpose of using such an exchange." Same source as #2. The underlying research is here.
5. ICE's parent institution is located in the Cayman Islands. It seems this is for tax reasons, is fully legal, and it has been approved by the Fed. MR readers will have different views on this set-up, I expect, but you can see why financial critics might feel leery. It also has been suggested that the Cayman Islands locale helps banks repatriate profits untaxed; it is not clear (to me at least) whether the new FinReg bill changes this arrangement. Is this all a reason why the clearing isn't going through the better-established Chicago Mercantile Exchange?
6. The Fed was regulating ICE but in the new FinReg bill the SEC and CFTC have joint authority over the institution, with overall the CFTC having the lead role for what is currently, or has been, OTC derivatives. Standards for regulation do not yet appear well fleshed out, here is one set of comments.
Here is a good article by Lucy Komisar on ICE. I don't want to sound too alarmist, I don't want to go back to non-clearinghouse days, and I wish to stress that these matters are hard to judge. Still, what I'm reading isn't reassuring me as much as I would have liked.