Ice Trust Describes Risk Management System That Aims to Thwart Contagion
September 16, 2009
Talk about responsibility. Anointed by the world’s largest banks as the leading central clearinghouse for credit default swaps (CDS), the IntercontinentalExchange’s ICE Trust has essentially promised the world that it can tame the risks in the $26 trillion over-the-counter market; one that some regulators and market participants say sped the downfalls of what were once three of the world’s largest financial players: AIG, Bear Stearns and Lehman Brothers.
Ice Trust is essentially the banks’ answer to regulatory calls to make the CDS market more transparent, after the sector’s labyrinth nature precluded easy remedies during and after Lehman’s collapse, and as AIG and Bear cratered, when quick solutions – namely clearer views of outstanding trading positions – were needed most.
In a two-part interview, Securities Industry News asked Ice Trust President Dirk Pruis how the risk management system Ice is employing would work to make sure participants in the CDS market have the financial wherewithal to trade and clear CDS contracts.
New York-based Ice Trust is the only player so far centrally clearing CDS domestically. The firm has cleared over $2 trillion in total or “notional” CDS trades in North American CDX indices since first launching the service in March. It also leads overseas: Through Sept. 11, London-based ICE Clear Europe has cleared $447 billion in notional iTraxx indices, far ahead of its closest competitor, Deutche Borse’s Eurex Credit Clear, which has cleared $131 million since its July debut.
Eurex, though, handled in August the first centrally cleared single-name CDS, a $7.1 million contract covering the debt of German utility RWE AG. ICE expects to begin clearing single-name CDS contracts before the end of September.
Can you give readers an idea of what Ice’s CDS risk management system does and why it should make people feel safe in its ability to find potential problems and make sure things work orderly and positions and money of members and their customers are protected?
Our systems were built from scratch specifically for the CDS market. Margin is collected daily based on the risk of a portfolio’s positions, and that’s done every day. In addition, those positions are separately marked-to-market every day and variation or mark-to-market margin representing the difference in price in the positions is also collected and paid daily. In addition to risk-based forward looking margin, there is a mutualized risk pool called a guarantee fund, which is also based on a clearing member’s portfolio. In our case, this calculation is based on two simultaneous defaults of our largest clearing members’ portfolios. The margin and the guarantee fund calculations are forward-looking using a five-day risk scenario. Looking at the largest losses generated based on how you stress those actual portfolios resulted in a strong, conservative approach. We were in testing with Lehman as a potential clearing member a year ago, so were able to test how their portfolio would perform were we clearing it during their default. This has been useful information for us and our regulators. Any clearinghouse would want to look at a highly stressed situation to review its models and to determine its risk of loss. So that’s how margin and a guarantee fund calculation are determined.
How did the Lehman Brothers scenario inform your buyside solution?
