The Atlanta-based company, known as ICE, will be the first U.S.-based clearinghouse owner to guarantee trades in the $27 trillion market for credit-default swaps after receiving approvals from domestic regulators last week. ICE is competing against CME Group Inc., the world’s largest futures exchange, NYSE Euronext, Eurex AG and LCH.Clearnet Ltd. as regulators look to impose restrictions on the swaps.

Firms taking a lead in developing trading systems that provide more stability and transparency to the swaps may generate as much as $400 million a year in revenue, according to Keefe Bruyette & Woods Inc. ICE’s partnership with eight of the largest trading banks made the company the favorite for analysts at Morgan Stanley, Creditsights Inc., Raymond James & Associates Inc. and Credit Suisse Group AG.

“We believe the strength of ICE’s platform and partnership with the broker-dealer community positions the exchange to capture a disproportionate amount” of credit-default swap trading, Patrick Pinschmidt, an analyst with Morgan Stanley in New York, said in a March 6 research report.

U.S. and European officials are developing plans to increase the amount of information available about the swaps after American International Group Inc., once the world’s largest insurer, almost failed from its use of the contracts. The unregulated, privately traded market hampered government efforts to assess bank credit risk because the full range of trades between dealers was unknown.

Default Hedge

Credit-default swaps are derivatives used to hedge against losses or to speculate on the ability of companies to repay their debt. The contracts pay the buyer face value in exchange for the underlying securities if a borrower fails to adhere to its debt agreements, and rise when investor perceptions of credit quality deteriorate.

A clearinghouse reduces risk by acting as a middleman between traders, providing guarantees in case one of the parties defaults on a transaction. In exchange, the clearinghouse collects a fee for every contract it processes.

As part of its plan, ICE paid $39 million last week for Clearing Corp., a Chicago clearinghouse, and agreed to share revenue from credit-default swaps with that company’s shareholders.

Sales Increase

Clearing Corp. is owned by dealers including New York-based JPMorgan Chase & Co., Goldman Sachs Group Inc. and UBS AG of Zurich. The clearinghouse may increase ICE’s revenue by $200 million a year, on top of $813 million in sales last year, based on Keefe’s estimates.

A decline in the size of the credit-default swap market may limit gains, Howard Chen, an analyst with Credit Suisse in New York, said in a March 5 report. The outstanding notional value of credit-default swaps has shrunk 56 percent since 2007 from $62 trillion.

The move into clearing swaps comes as ICE and CME face a decline in volume for their main futures trading businesses. Futures trading will drop as much as 20 percent this year in financial and energy contracts, Morgan Stanley’s Pinschmidt said in a January note to clients. ICE shares dropped 57 percent last year, while CME Group plunged 70 percent.

CME spokesman Allan Schoenberg in Chicago didn’t respond to a request for comment.

Fee Growth

Even with a shrinking market, Chen said revenue would be $400 million to $700 million over the next three to five years. Banks may use several clearinghouses until the market matures, even if they are shareholders in ICE, he said.

ICE rose $2.38, or 4.1 percent, to $60.39 on March 6 in New York Stock Exchange composite trading. CME closed at $182.45 in Nasdaq trading.

Fees from clearing credit-default swaps may grow at a 12 percent annual compound rate through 2011, according to Kevin McPartland, a senior analyst at TABB Group, a Westborough, Massachusetts-based financial-services consulting firm. He puts revenue from clearing, electronic trading and processing existing over-the-counter credit swaps at $174 million within two years.

ICE received final approval for clearing March 6, when the U.S. Securities and Exchange Commission granted the company an exemption to begin processing contracts. The day before, the Federal Reserve, which will oversee the clearinghouse, granted ICE’s request. The acquisition of Clearing Corp. was approved by the Federal Trade Commission and the Justice Department March 3.

Chicago’s CME hasn’t yet received an exemption from the SEC, the only regulatory hurdle it faces before offering clearing of the contracts. SEC spokesman John Nester said March 6 he didn’t know when a decision would be made.

LCH.Clearnet has said it wants to clear credit-default swap trades by December and Eurex said last week it will concentrate on clearing European trades. NYSE Euronext started clearing in December, though no contracts have been cleared through its system yet.

 SOURCE: Bloomberg