Wednesday, August 24, 2005

Trouble Ahead, Trouble Behind

Fed Summons 14 Banks to Discuss Credit-Derivatives Controls

Aug. 24 (Bloomberg) -- The Federal Reserve Bank of New York invited 14 of the ``major participants'' in the credit- derivatives market to a meeting next month amid concern the $8.4 trillion industry is rife with unconfirmed trades.

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.

The credit-derivatives market more than doubled in the past year, giving companies, investors and governments the ability to bet on or protect against changes in credit quality. A backlog of confirmed trades may undermine investor confidence, a group led by E. Gerald Corrigan, managing director at Goldman Sachs Group Inc. and a former New York Fed president, said last month.

The Counterparty Risk Management Policy Group, the banking industry group led by Corrigan that first met in 1999 after the collapse of hedge fund Long-Term Capital Management, said in a report on July 27 that ``urgent'' effort is needed to tackle the ``serious'' accumulation of trade confirmations. Banks should be prepared to consider reducing trading until the deals are confirmed, the report said.

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.

`Senior' Executives

The Fed's letter said ``a senior business representative and a senior risk management person,'' should attend the meeting.

Credit derivatives are the fastest growing part of the $24 trillion derivatives market, based on the so-called notional value of the debts 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.

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.



To contact the reporters on this story:
Hamish Risk in London at hrisk@bloomberg.net;
Justin Baer in New York at jbaer1@bloomberg.net
Last Updated: August 24, 2005 14:34 EDT

http://www.bloomberg.com/apps/news?...=top_world_news

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