February 23, 2000

A simple definition of credit derivatives? Not possible. Try this one out. According to a fact sheet, “credit derivatives allow the transfer of credit risk between two counterparties—i.e. the buyer of the default protection pays an annuity to the seller of default protection in regular intervals in exchange for a contingent payment to be made by the seller of protection based on certain credit events occurring.” Right.

If that makes sense to you at all then CreditEx.com is a godsend. The site is set to be the first online trading system for credit derivatives, an over-the-counter market that is the financial equivalent to the Wild West. With no central clearing house and with every derivative unique, the marketplace has been fairly illiquid. CreditEx seeks to change all that, providing a single destination for information and execution capabilities, increasing transparency and, as always, liquidity.

Although the credit derivatives market is only a little over a decade old, the U.S. market already totaled $100 billion in 1998 and the global market $300 billion. According to industry estimates, the credit derivatives market is growing at 110% in notional volume a year and will soon top $1 trillion. Founded by Sunil Hirani and John McEvoy—former Deutsche Bank derivatives specialists—CreditEx seeks only a small portion of that entire pie, but a small portion is more than good enough for them.

“I think we can be a successful business with a relatively small percentage of the market,” explains Hirani. “Dealers have suggested to us that we could garner tens of a percent of the market. That would be in our wildest dreams, but dealers are telling us this, that we will have a larger percentage of the business flow.”

McEvoy says that CreditEx is fully aware that the large dealers will still want to maintain their personal relationships with their clients, and that the CreditEx trading system will serve to complement the distribution process rather than replace it.

Fifty institutions have already signed up with CreditEx, and the online trading site counts as investors the Bank of Montreal, J.P. Morgan Securities, Morgan Stanley Dean Witter, Deutsche Bank and Canadian Imperiale Bank of Commerce. The execution capabilities are already in the beta stage, and CreditEx expects to go live with them by the end of the first quarter.

Hirani and McEvoy decided to use the Internet as its communication platform, rather than a proprietary network, because they felt that the Internet would allow the system to be more quickly adopted. They developed their online derivative contracts according to standards set in 1999 by the International Swaps and Derivatives Association (ISDA).

“Every transaction has been a one-off transaction, and this was the first time you really had a standardized contract that the market could adopt,” Hirani explains, pointing to the 1999 ISDA standards.

Along with trading functionality, CreditEx has struck partner relationships with the likes of KPMG Peat Marwick and other analytics providers in order to give their clients all the information and tools they will need to better understand and measure risk all from one desktop.