| Confirmation of derivative transactions a prime concern for an increasing number of financial authorities |
|
|
| 18/12/2005 | |
|
About three months after the Federal Reserve Bank of New York, the Dutch central bank, De Nederlandsche Bank, has gone public with its own concerns about credit derivative transaction counterparty risks. As for the NY Fed, the Dutch central bank focuses on the late confirmation issue, which increases the risks associated with those transactions. Confirmation allows for the verification of a transaction's details while ensuring compatibility between the counterparties' back office systems. Substantial confirmation backlogs have been created due to the double whammy of incongruent, often paper-based, back office systems and a fast growing market. According to the International Swaps and Derivatives Association (ISDA), the notional amount for credit derivatives stands at $12.43 trillion - up 48% in the first six months of the year. Credit derivatives as defined by the ISDA, includes credit default swaps, baskets and portfolio transactions indexed to single names, indexes, baskets, and portfolios. The ISDA reported in June 2005 that only 40% of contracts are automatically confirmed, up from 24% in 2004. It takes hedge funds and banks in the US, which are amongst the largest credit derivative market participants, an average of 11.6 days to properly confirm a credit derivative transaction (down from 17.8 business days in 2004). The Dutch central bank says that late confirmation puts significant pressures on industry players. "Any delays increase the risk of parties misjudging their position", reports De Nederlandsche Bank in its "Overview of Financial Stability in the Netherlands" publication. "Another noteworthy issue of credit derivative transactions is that positions are sometimes transferred to third parties (assignments) before the original parties have agreed on this. As a consequence, it is not entirely clear on which parties the (credit) exposures are outstanding." Solution To curtail those back office problems, 14 credit derivatives dealers submitted a draft proposal to the New York Federal Reserve Bank back in September 2005. Among other measures, the dealers committed to improve substantially their controls of credit derivative assignments, as well as to spread the use of electronic matching. Their strongest commitment was for the setting of a timetable for reducing confirmation backlogs. To this end, a target date for trimming down the confirmation backlog has been set for January 31, 2006. By then, said the "Major Dealers", the number of confirmations outstanding more than 30 days will be reduced by 30% from their September 30, 2005 level. Adding that they would make all their market data available to the authorities, the dealers said that their commitment was "aggressive" specifying that "anything less than significant progress on our backlogs over and above our January 31, 2006 goals will be unacceptable." That was after the GM and Ford credit events, but before the bankruptcy of auto parts supplier Delphi. The dealers had been wise enough to add in their letter that one or more major credit events affecting large volumes of contracts could significantly impact their ability to meet their self-imposed deadline. Four days after the letter was made public, Delphi filed for bankruptcy protection, defaulting in the process on bonds worth $200 billion and impacting the settlement of $28 billion in credit-derivatives contracts, mostly credit default swaps that provided protection against Delphi's default, putting further strains on dealer back office systems. One senior investment banker told the Dow Jones Wire Service that some of the signatory dealers would not make the January 31 deadline. J.L. |
|
Related articles |
|
Articles of the same Topic : Derivatives |
|
© Copyright 2008 bfinance. This document is for your personal non-commercial use. Any further copying, reproduction, distribution is strictly prohibited. To obtain permission please contact This e-mail address is being protected from spam bots, you need JavaScript enabled to view it