Buy-side firms may see an increased role in the clearing of single-name credit default swaps (CDS) in response to a diminished client-clearing business.
Asset managers have stepped up their demands for central clearing of single-name contracts in a bid to revive liquidity, bring market makers back to the forefront, and restore confidence in the CDS market.
However, capital restraints have forced some dealers to pull back from their traditional clearing and market making capabilities. In November last year, Deutsche Bank said it will stop trading most CDS contracts tied to individual companies.
As this trend continues, large buy-side players may be encouraged to fill the void in the clearing space.
“We haven’t seen the IDBs (interdealer brokers) come to play in this space to make markets like we used to with bilateral trading. They are not playing the same intermediary role in driving up volume,” says Joshua Satten, director of business consulting at Sapient Global Markets.
“So you have a situation where there is a decline in both the number of FCMs and interdealer banks to execute and clear trades. Who is going to step in and perform those vital roles?”
According to Satten, this is where dis-intermediation could come into play, with buy-siders seeing the benefits of providing pricing and transparency themselves through direct clearing membership.
Earlier this week, Eurex launched a new service to allow buy-side firms to become directly connected with their clearing house.
In addition last year, Citadel Securities became the first non-bank clearing member of LCH.Clearnet for interest rate derivatives. Other large asset managers, therefore, could be inspired to become a direct clearing member for single-name CDS.
“What we have is large asset managers and large pension funds that could potentially step in as market makers as well as become direct clearing members of CCPs,” Satten explains.
“But it remains to be seen which buy-side firms might become self-clearers, and which ones will become market makers. But I think that there could be the trend here as we’ve seen recently in the interest rate space – some larger asset managers might look to self-clear, and those who do in the single name space will also look to become market makers.”
According to data compiled by IntercontinetalExchange (ICE), buy-side notional cleared volumes for single name products at ICE Clear Credit amounted to $57.6 billion as of February 2016.
Earlier this year, the European Commission approved a central clearing mandate for certain European-denominated single-name CDS contracts.