Regulators strangle credit swap market

Bloomberg

Outstanding contracts fell 38 percent in 2008, the New York-based International Swaps and Derivatives Association said in a survey released in Beijing yesterday. It’s the first annual decline, after the market increased 100-fold over the previous seven years as investors used the derivatives to protect against bond losses and speculate on creditworthiness.

Dominoes falling
Traders have been rushing to cancel redundant trades as federal authorities seek to impose regulations on the market for the first time since it was created a decade ago.

After the collapse of Bear Stearns last year, 17 banks that handled about 90 percent of trading in default swaps agreed to initiatives including trade compression to help reduce day-to-day payments, bank staff paperwork and potential for error.

"In the current environment, firms are intensely focused on shrinking their balance sheets and allocating capital most productively," said ISDA Chief Executive Robert Pickel, whose group represents dealers that control trading.

More than 2,000 banks, hedge funds and asset managers trading credit-default swaps agreed to a "Big Bang Protocol" this month that aims to improve transparency and confidence in credit-default swaps.

It changes the way the swaps are traded so that it’s easier to eliminate offsetting trades and move them through a clearinghouse.

Calls for overhaul
Regulators including the Federal Reserve Bank of New York have called for an overhaul of the industry that was blamed for speeding the collapse of Bear Stearns, Lehman Brothers and American International Group.

The tear-ups, which don’t reduce the actual amount of default and market risk outstanding, may reduce the amount of capital that commercial banks are required to hold against the trades on their books.

The U.S. banking industry had its first loss in derivatives trading last year, the Office of the Comptroller of the Currency said March 27. Commercial banks lost $836 million trading over-the-counter cash and derivatives contracts, including $9.2 billion in the fourth quarter, compared with a $5.5 billion gain in 2007.