A light touch

Isda's chairman, Jonathan Moulds, talks to Alexander Campbell

Rating agencies have come under fire for their role in the credit crisis, and have been accused of reacting too late to changes in credit market conditions. But the sector has received some support from at least one quarter - the International Swaps and Derivatives Association. Isda's chairman, Jonathan Moulds, concedes the agencies may have struggled to keep pace with innovation in the structured credit market, but argues many investors had come to depend too heavily on ratings.

"I think firms became too over-reliant on them. The rating agencies have a difficult job - there are rapidly changing credit conditions and a huge number of products to rate and ratings to keep up to date. It's tough for them to keep pace," says Moulds, who is also president of Europe, Middle East, Africa and Asia at Bank of America.

Turmoil in the credit markets has caused multi-billion-dollar writedowns at investment banks across the globe - in some cases, eating into capital reserves. In this environment, the introduction of the Basel II framework, which came into full effect in Europe and parts of Asia and the Middle East in January, may have come at the wrong time. "Is the timing right? I think that's open to question," Moulds says. One of the side-effects of the new rules is that banks could be required to increase capital reserves in economic downturns - precisely the time when additional capital is hardest to obtain, he adds.

Nonetheless, he concedes banks have had plenty of time to prepare for the new rules - the first Basel II consultative document was published in 1999. "Banks have had enough lead time to be prepared. If you look at the constructive ways they are dealing with writedowns and raising capital from sovereign wealth funds, they have a number of ways to bolster capital if they need to. They should be well prepared."

Much of the blame for the turmoil that swept the markets in the second half of last year has been laid at the door of the credit derivatives markets. Two causal chains have been suggested by market observers: the existence of a well-developed and liquid credit default swap market, which may have deepened the downturn by making it easy for traders to go short credit; and the development (encouraged by the introduction of Basel II, among other things) of the originate-to-distribute model, which has made it difficult for investors to identify where US subprime mortgage exposures are residing.

Moulds defends these developments. "There are many more ways that people can go short credit, but that's part of the growth and sophistication of the market. Having a two-way market and a way to offset risk in a liquid fashion offsets any potential downside."

Securitisation also has benefits that far outweigh any negative impact from the originate-and-distribute model. "Broadly, diversification of risk must be regarded as positive," he says. "In terms of risk concentration, it's hard to know where 100% of the risk sits, but there is a net benefit. Individual organisations and regulators must establish a framework of what's appropriate for people to hold."

That doesn't mean some of the more complex products of the structured credit market will ever return. "There will be room for innovation, but in general we will see a focus on simpler products. There is still a lot of scope in equity derivatives. I think the market can continue to grow - basket trades are a simple concept but there is tremendous demand for them. And with the rate curve steepening, we will get more market volatility and a terrific demand for rate products."

Looking forward, he says Isda will continue to help develop regulations on derivatives trading around the world - and sees the association's expansion into emerging markets in Asia and Latin America as the most important development of his chairmanship. "It's a central part of what Isda does. For the most part, regulators are pretty sophisticated and we have come to a light-touch regulatory environment, which works well. It's not obvious at all how tighter regulation would improve stability in the market."

Alexander Campbell.

Biography: Jonathan Moulds

2006: Bank of America (BoA) president for Europe, Middle East, Africa and Asia

2005: Head of international markets, BoA

2004: Chairman, Isda

2001: Head of global derivatives group, BoA

1998: Director, Isda; head of rates derivatives trading, BoA

1996: Joins BoA.