Saturday, April 4, 2009

Institutions Selling Credit Protection Need to Have Enough Capital in Addition to Using Central Clearing House for Credit Default Swaps

There is currently no single authority with responsibility for requiring institutions selling credit protection to have enough capital or reserves to back up the Credit Default Swaps transactions.

The reason for the gap is the US Congress’ enactment in 2000 of the Commodity Futures Modernization Act, which eased restrictions on derivatives such as CDSs. The solution also has to come from Capitol Hill. But arguments over which agency—whether the Federal Reserve, the Commodities Futures Trading Commission, the Securities and Exchange Commission or a combination of these institutions—should be given the authority to regulate the over-the-counter CDS market are hampering efforts to plug regulatory loopholes.

Meanwhile, market players are focusing on establishing a central counterparty or clearinghouse for CDSs. Five groups—NYSE Euronext, IntercontinentalExchange, CME Group, LCH.Clearnet and Eurex—have asked US and European authorities for permission to act as central counterparty for CDS trades in either or both jurisdictions, and some of them have received approvals.

“A well-functioning market for spreading credit risk is a source of strength and resilience for a financial system and I hope and I expect that the reforms that to be put in place will be in the direction of strengthening the foundation of the system and removing some of the excesses that have taken place. One of the areas it can be strengthened is in the settlement mechanism so that less is done in pure bilateralism and more is done through central clearing mechanisms. I think more can be done in the area of more transparency, too,” said Andrew Crockett, president of JPMorgan Chase International, last month.

But while the establishment of a central clearinghouse will help towards making the CDS market more transparent and reducing counterparty risks, there are still concerns about the soundness of the institutions offering credit default insurance. And until there are regulations to ensure the providers of credit protection are themselves reasonably protected from failure, confidence in the financial system will not be fully restored.

(from The Asian Banker)

No comments:

Post a Comment