The planned merger of two companies working together to establish a credit-default swap clearing house has bolstered the case for Federal Reserve Board to have ultimate oversight of the $60 trillion CDS market, observers say.
IntercontinentalExchange Inc. of Atlanta, which has been working with Federal Reserve Bank of New York to launch a central clearing house in New York for the swaps, said Thursday that it is buying its partner in the project, Clearing Corp., a Chicago firm that has won the backing of such major CDS players as JPMorgan Chase & Co., Bank of America Corp., and Morgan Stanley.
The Fed already has oversight of the ICE clearing house, which is being established as a limited-purpose bank, and Clearing Corp.'s support from big dealers has given the clearing house more attention than a rival project headed by CME Group, which is set to be regulated by the Commodities Futures Trading Commission. Thus, in the turf war over which agency will regulate financial derivatives, the Fed appears to have a leg up, said Chris Low, the chief economist at First Horizon National Corp.'s FTN Capital Financial.
"Everyone is now a bank, the biggest players are adhering to that set of rules, and it makes sense that they'd be more open to having the Fed overseeing that part of their business," Mr. Low said.
The CFTC has long asserted itself as the rightful regulator of over-the-counter financial derivatives, but to little avail.
Some say that ICE's advance puts CME Group's effort on shaky ground. "I would think it would have a dampening effect on how successful the CME Group is going to be," said Gil Schwartz, a partner at Schwartz & Ballen LLP. Mr. Schwartz, a former Fed lawyer, said the market's lack of confidence in the stability of credit counterparties could extend into the new clearing houses and make one look more desirable than the other.
CME Group, also of Chicago, has conceded no ground. The company told Dow Jones last week that an ICE-Clearing Corp. merger would not shut CME out. "There's room for multiple parties to enter into this space to clear credit-default swaps," said Terry Duffy, CME's chairman.
CME Group also says its clearing house could be functioning this week, while the launch date for the ICE clearing house, though it is expected sometime in the fourth quarter, is less certain.
A spokesman for the CFTC said: "Participants in the markets will be able to select whichever entity they wish to clear their CDS through."
The New York Fed declined to comment.
Ernest Patrikis, a partner at Pillsbury Winthrop Shaw Pittman LLP, said the Fed's expertise in clearing and settlement operations has long been recognized. "I think the Fed just has natural strengths in this area and has it globally," he said.
What remains unclear is which segments of the CDS market — its trading behavior, settlement options, players, and systemic risk — will be regulated. Mr. Patrikis said all market players would be supervised in the future.
Kip Weissman, a partner at Luse Gorman and a former attorney for the Securities and Exchange Commission, said popularity of a Fed-supervised clearing house does not necessarily mean the Fed will wind up regulating the entire CDS business. "It's not the end of the game," he said. "I think it's going to be dictated by the larger regulatory structure, created by self-regulation, state regulation, and international regulation."