Banks Agree to EU Demand for Credit-Swaps Clearing

By Shannon D. Harrington and John Rega

Feb. 19 (Bloomberg) -- Dealers of credit-default swaps in Europe agreed to use a clearinghouse to guarantee derivatives as they seek to end a threat by regulators to legislate the privately traded market.

Banks and brokers committed to start using a Europe-based clearinghouse as early as the second half of 2009, said two people familiar with the matter, who declined to be identified before an announcement planned for as soon as today. Funded by its members, a clearinghouse adds stability to markets by becoming the buyer to every seller and the seller to every buyer.

Dealers are under pressure to process credit-default swaps trades through a central counterparty in the U.S. and Europe after last year’s failure of Lehman Brothers Holdings Inc., which was among the largest traders of the contracts. While the U.S. led the push toward clearing last year, European regulators are taking charge, according to Brian Yelvington, an analyst at CreditSights Inc. in New York.

“They’ve definitely taken a firmer regulatory stance and outlined what they wanted,” said Yelvington, a former credit- default swap trader. “In the U.S. they encouraged things, but no real entity has been empowered to do it.”

The Federal Reserve Bank of New York last year encouraged dealers to commit to processing trades through one of four clearing entities being created by exchanges.

Pushing Dealers

European Union Financial Services Commissioner Charlie McCreevy has said he would push for a law forcing dealers to conduct clearing in the EU, under the supervision of regulators, if the banks didn’t do it voluntarily. With his backing, lawmakers have proposed that banks set aside extra money for credit derivatives that aren’t safeguarded in a clearinghouse.

The EU and regulators in the U.S. have sought to increase oversight of the market amid claims that bets made with the contracts amplified the credit crisis. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent if the borrower defaults.

Bets made through credit-defaults swaps helped push American International Group Inc., once the world’s biggest insurer, to the brink of bankruptcy before the U.S. government bailed it out with a $150 billion rescue 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.

Competing Clearinghouses

Atlanta-based Intercontinental Exchange Inc., Chicago-based CME Group Inc., Eurex AG and NYSE Euronext’s Liffe derivatives market are competing to clear credit-default swaps.

Resistance from banks and authorities in continental Europe has held up efforts to clear European trades, NYSE Euronext Chief Executive Officer Duncan Niederauer said last month in Davos, Switzerland. NYSE Euronext’s Liffe derivatives exchange in London started offering credit swaps clearing in December through LCH.Clearnet Group Ltd.

“The solution we’ve established for a very legitimate clearinghouse is somehow not acceptable to the continent because it’s not in the eurozone,” Niederauer told the lunch gathering hosted by Credit Suisse Group AG on Jan. 30. “It all seems like nonsense to me. We should think about trying to solve the problem, not playing politics here.”

LCH.Clearnet said last week it will start offering clearing through a Paris-based unit to meet European regulators’ demands.

France’s central bank urged the creation of a eurozone clearinghouse to prevent the business from going to the U.S. or the U.K., the Financial Times reported today, citing a Banque de France report.

Nine dealers in October backed the plans by Intercontinental Exchange, or ICE, which is acquiring dealer- owned Clearing Corp. The ICE clearinghouse still needs the approval of the Federal Reserve Bank of New York and other regulators.

To contact the reporter on this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net; To contact the reporter on this story: John Rega in Brussels at jrega@bloomberg.net.