In a report published today, the Bank for International Settlements (BIS) highlighted disclosure, concentration and the role of ratings agencies as key features of the credit risk transfer market that may need to be addressed with regulation.The BIS’s report on credit risk transfer – written by Committee on the Global Financial System working group – echoes concerns raised last year by the Bank of England and the International Monetary Fund (IMF) that a lack of transparency may allow dangerous concentrations of credit risk to develop.
The working group said that its findings on the lack of disclosure about credit risk transfer among banks and insurers may give “grounds for concern”, and that disclosure was “all the more important” when considering credit default swaps because of possible leverage effects.
The BIS described the vanilla default swap broker-dealer market as continuing to be “highly concentrated”, according to information gathered from several sources, including Risk magazine’s annual credit derivatives surveys. While saying a downturn in the creditworthiness of large intermediaries had the potential to disrupt markets, the BIS concluded that the concentrations of liquidity may simply be a consequence of the market’s infancy. And even relatively developed derivatives markets such as foreign exchange and interest rates are dominated by just a few banks.
The BIS also said ratings agencies had “in effect become standard setters for the tranching of portfolio credit risk,” but that “there are nonetheless questions about how ratings can provide a consistent measure of risk.”
Concerns about ratings agencies’ methodologies have recently surfaced among investors in bespoke credit products - typically single tranche deals where the remainder of the capital structure is not issued. Some investors claim that dealers are involved in systematic ratings arbitrage (Risk January 2003, page 42).
Quoted in the January 2003 issue of Risk, Andrew Jackson, London-based senior director in the credit products group at Fitch Ratings said: “In the past, there has clearly been some ratings arbitrage. But compared with one year ago, we are now much wiser to this possibility.”
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