10 July 2008

US officials on challenges for a CCP for clearing CDSs

US regulators are discussing whether and how the market for OTC derivatives contracts might benefit from a central clearing party for the CDS market. A well-designed clearing house could still face significant challenges, they say.

US regulators such as the SEC and the Federal Reserve are discussing whether and how the market for OTC derivatives contracts might benefit from a central clearing party for the CDS market. In their testimonies before the US senate, Fed deputy director Patrick Parkinson and SEC Chief Economist James Overdahl focused on the oversight of the credit derivatives markets by the prudential supervisors.

 

Supervisors and other policymakers should encourage the introduction and use of well-designed CCP clearing services for credit derivatives and should encourage greater standardization of contracts, Parkinson said.

 

However, “we do not see a need for legislative intervention to supplement our ability to regulate the credit derivatives of national banks” OCC Deputy Comptroller Kathryn Dick said.

 

Speakers noted that while a well-designed clearing house in the credit derivatives market could reduce risks to the financial system, it could also face significant challenges.

 

Developing a central counterparty for clearing CDSs would be an important step forward for the credit derivatives market, Overdahl noted. However, a paramount concern would be the ability of the CCP to implement sound risk management practices.

 

“One should not view a CCP as a silver bullet for concerns about the management of exposures related to credit derivatives”, Overdahl said. “Even with a CCP, preventing a systemic risk build-up would require dealers and other market participants to manage their remaining bilateral exposures effectively and the dealers' management of their bilateral exposures would require ongoing supervisory oversight.”

 

Although a CCP has the potential to reduce counterparty risks to OTC derivatives market participants it concentrates risks and responsibility for risk management in the CCP, Parkinson warned and called for effective risk controls. 

 

“If its controls are weak or it lacks adequate financial resources, introduction of its services to the credit derivatives market could actually increase systemic risk”, Parkinson said.

 

Testimony Parkinson

Testimony Overdahl

Testimony Dick