ICE Clear to Offer First Clearing for Sovereign Credit Swaps (BusinessWeek)

I’ve done a lot of thinking about this over the past few months – is it feasible for a clearinghouse to clearing CDS of its members (say, CDS on GS debt) or of sovereign  debt, especially debt of the country where the CCP sits (e.g. ICE Clear clearing CDS on US debt).  Too much wrong way risk exists to treat either case the same as other CDS – basically, the worse things got the worse they would get.

If a bank clearing member was nearing default, the other members would simultaneously be worrying about the impact on the clearinghouse as a whole while also needing to post additional margin because of the continuously widening CDS spread.  A double whammy on the system.  And as per my comments below, cleared sovereign CDS create an even more systemically risky situation.

Two important points to note: the market needs these instruments to hedge risk, so they can’t just go away. And second, their are ways for the CCP to deal with the additional risk – its just unclear (no pun intended) if those ways would make the products unattractive:

“The banks and sovereigns are where people are concerned about risk the most today,” said Kevin McPartland, director of fixed-income research in New York at Tabb Group, a research and advisory firm. “This is an exposure people need to manage, so we need to figure out a way to manage it.”

“Look at Greece possibly defaulting, it’s causing a global disaster,” he said. “Can you imagine if Germany defaulted? A clearinghouse wouldn’t do any good. There’d be a knock-on effect to every systemically important institution in the world.”

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