UPDATE: NY Fed Calls For More Progress In OTC Derivatives
April 01 2009 - 5:55PM
Dow Jones News
The New York Federal Reserve said Wednesday that major dealer
banks and buy-side firms need to do more to reduce risk in
over-the-counter derivatives markets.
Representatives of fifteen major banks met with regulators in
New York to discuss progress in bringing central clearing to OTC
derivatives markets, particularly for credit default swaps.
"Recent events underscore the need for more progress in reducing
risk in the OTC derivatives market," said William C. Dudley, New
York Fed President.
While some progress has been made, Dudley said, "Banks and
buy-side firms still need to make considerable improvements to both
risk management and the design of the OTC derivatives markets."
The meeting follows the launch earlier this month of the first
U.S.-based clearinghouse for credit derivatives, at the behest of
regulators and market participants seeking better transparency and
reduced risk in the $28 trillion CDS market.
The size of the market has halved over the last six months as
participants net down the notional value of outstanding trades.
That process, along with clearing, represents efforts to get a
handle on instruments that have been blamed for the downfall of
insurer American International Group Inc. (AIG).
U.S. Treasury Secretary Timothy Geithner has endorsed the
central counterparty remedy for the credit derivatives market,
calling last week for all over-the-counter trades to be
cleared.
The bank-backed clearinghouse operated by Atlanta-based
IntercontinentalExchange Inc. (ICE) remains the only operational
facility for credit derivatives in the U.S.
At issue is when membership in the clearinghouse, called ICE US
Trust, will be opened up to buy-side participants and other
institutions.
Since launching March 9, membership in the clearinghouse has
been limited to the nine biggest U.S. banks, including JPMorgan
Chase & Co. (JPM), Goldman Sachs (GS) and Bank of America
(BAC), who collectively are seen to represent the majority of
credit default swap trading activity.
This has drawn criticism from competitors, who see ICE and the
banks maintaining a so-called dealer's club in the market.
Part of the argument hinges on segregation of customer funds, a
process that protects buy-side client capital in case the bank
through which a trade is done goes into bankruptcy.
While the structure of ICE's CDS clearinghouse affords this
protection to the clearing member banks, it doesn't currently
extend to the hedge funds and other participants trading credit
instruments through those banks.
Gary DeWaal, general counsel at futures commission merchant
Newedge USA, said regulators are pushing to open up the ICE
platform to broker access, as many proprietary trading shops and
hedge funds access the clearinghouse indirectly through their
brokers.
"Frankly, that's a good system, because it provides another
level of protection around the clearinghouse," DeWaal said.
A competing CDS clearing platform developed by CME Group Inc.
(CME) and Citadel Investment Group aims to have a broader
membership, incorporating buy-side firms from the start, according
to Kim Taylor, president of CME's clearinghouse.
CME's platform, dubbed CMDX, secured regulatory approval in
mid-March but has yet to launch.
Fed board members have been monitoring the relatively slow
progress in transitioning the CDS market to clearing, having
originally aimed to have the first platform up and running by the
end last year.
"It's a de novo presence [now] but a very important step that's
been taken," Dallas Federal Reserve Bank President Richard Fisher
told reporters last week. "Clearly this will evolve over time."
Volume on the ICE Trust platform has grown since its March 9
launch, with a notional value of about $45 billion in credit
derivatives trades guaranteed as of March 27.
However, the platform has yet to handle any new business, with
activity so far limited to back-loading of existing positions.
The slow march toward credit derivatives clearing has been
mirrored in Europe, with the CDS clearinghouse established by NYSE
Euronext (NYX) yet to handle a trade.
Banks also face a potential split in Europe, with most CDS
business conducted through London, while euro-zone members have
been pressing for a separate platform to handle business in their
region.
-By Jacob Bunge, Dow Jones Newswires; (312) 750 4117;
jacob.bunge@dowjones.com
(Doug Cameron contributed to this article.)