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Fed Summons 14 Banks
to Discuss Credit Derivatives
By Hamish Risk and Justin Baer
Bloomberg News Service
Wednesday, August 24, 2005
http://www.bloomberg.com/apps/news?
pid=10000103&sid=aIAtxJa2MRVI&refer=us
The Federal Reserve Bank of New York has invited 14 of the "major
participants" in the credit derivatives market to a meeting next
month amid concern that the $8.4 trillion industry is rife with
trades lacking key paperwork.
The meeting at the Fed's New York office on Sept. 15 will focus on
market practices, according to an Aug. 12 letter sent to bank chief
executives by New York Fed President Timothy Geithner. Fed spokesman
Peter Bakstansky confirmed the letter's contents and declined to
name the firms invited.
Demand for credit derivatives, which companies, investors, and
governments use to bet on or protect against changes in credit
quality, more than doubled in the past year. A backlog of trades
left unconfirmed may undermine investor confidence, according to an
industry group led by E. Gerald Corrigan, managing director at
Goldman Sachs Group Inc. and a former New York Fed president.
The "serious" need to tackle the accumulation of trade confirmations
is "urgent," the Counterparty Risk Management Policy Group wrote in
a July 27 report. The committee, which first met in 1999 after the
collapse of hedge fund Long-Term Capital Management, asked banks to
consider reducing trading until the deals are confirmed.
JPMorgan Chase & Co., Deutsche Bank AG, Goldman Sachs Group Inc.,
Morgan Stanley, and Merrill Lynch & Co. dominate the credit
derivatives market as the five most-cited trading partners,
according to Fitch Ratings.
The International Swaps and Derivatives Association, a trade
group, "welcomes the regulatory attention to operational issues in
the credit-derivatives industry," ISDA Chief Executive Robert Pickel
said in a statement. "ISDA has also put its weight behind and
garnered the support of member firms' front offices in undertaking a
series of high-level initiatives targeted at tightening derivatives
transactions processing."
The Fed's letter said both "a senior business representative and a
senior risk management person" should attend the meeting.
Representatives from the U.S. Securities and Exchange Commission,
the Office of the Comptroller of the Currency, the New York State
Banking Department, the U.K.'s Financial Services Authority,
Germany's Federal Financial Supervisory Authority, and the Swiss
Federal Banking Commission also will attend, Bakstansky said.
Credit derivatives are the fastest growing part of the $24 trillion
derivatives market, based on the so-called notional value of the
debt underlying the contracts.
A derivative is a financial obligation whose value is derived from
interest rates, the outcome of specific events, or the price of
underlying assets such as debt, equities and commodities.
Investors use credit-default swaps to bet on a company's
creditworthiness or protect against non-payment. The contracts are
the most common credit derivative.
Like insurance, buyers pay an annual fee similar to a premium to
protect a certain amount of debt against default for a specified
number of years. In the event of a default, they get the face value
of the bonds or loans.
The settlement process for credit-default swaps is resource
intensive, and typically requires faxed signatures. Banks and
companies risk getting swamped by investors seeking settlement on
their contracts in the event of a corporate default, Corrigan's
group said.
One of the delays to confirming trades is the so-called assignment
process, in which an investor buys a contract and then sells it to a
third party. The paperwork for these transactions takes three times
as long to process, raising concern that the contracts might not
hold up in the event of a default.
Derivatives traders must ensure they have systems and controls in
place to keep up with the growth in their business, the U.K.'s
Financial Services Authority said in a letter to companies this
year.
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