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.)