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BoE says back-office delays still a risk

Delays in trade confirmations are still a problem in the credit derivatives market and expose the industry to unnecessary risk, according to a report by the Bank of England (BoE).

In its latest Financial Stability Review, published on June 27, the bank says growth in credit derivatives trading is continuing to accelerate, and warns: "Confirmation backlogs potentially leave firms vulnerable if they cannot ascertain the size and nature of their exposures when a credit event occurs. According to market contacts, the problem is exacerbated by some hedge funds assigning trades to third parties without informing the original dealer." This could make risk management difficult under stress conditions, the report adds.

The BoE also highlights shortcomings in pricing models, which fail to take implied correlation into account, and adds that value-at-risk fails to capture model risk, liquidity risk and basis risk. It says stress tests are also unreliable if based on historical events rather than hypothetical scenarios.

Mizuho kick starts insurance business

London-based Mizuho International has unveiled an insurance derivatives business, to be headed by newly appointed Stefan Roggenkamp.

The business will originate and structure insurance-linked securities – instruments that bridge the insurance and capital markets – directly from the insurance industry, as well as corporate entities.

Roggenkamp joined the firm in April 2005 after 10 years with HVB, where he was director of alternative risk transfer. Since joining Mizuho, he has hired Armin Wagner, a portfolio manager from HVB, and Kai Morgenstern, formerly a senior underwriter of GE Franconia Re as part of his team.

"There are a number of similarities between the insurance derivatives market now and the credit derivatives market eight or so years ago," says Marc Petrocochino, managing director responsible for proprietary and arbitrage desks at Mizuho, commenting on the potential for growth in the market.

"John Coomber, chief executive of Swiss Re, predicted in a recent interview that the reinsurance industry will securitise 30% of its turnover by 2015. We see absolutely no reason to question that figure," adds Roggenkamp.

US banks hold $91 trillion in derivatives, says OCC

The notional volume of derivatives held by US banks rose by $3.2 trillion to $91.1 trillion in the first quarter of the year, according to the US Office of the Comptroller of the Currency (OCC).

Most of this volume represented interest rate contracts, up $2.5 trillion to $78 trillion, while foreign exchange contracts were down $94 billion to $8.5 trillion. Credit derivatives volume increased by $777 billion to $3.1 trillion. Five banks still dominate the market, holding 96% of the total notional volume.

A total of 91% of contracts were traded over-the-counter and 9% were exchange-traded. "OTC contracts tend to be more popular with banks and bank customers because they can be tailored to meet firm-specific risk management needs," the OCC says in the report. "However, OTC contracts expose participants to greater credit risk and tend to be less liquid than exchange-traded contracts, which are standardised and fungible."

Credit exposure was down slightly in the quarter, falling $22 billion to $198 billion net of enforceable netting agreements, which reduced 83.7% of gross credit exposure, says Kathryn Dick, the OCC's deputy comptroller for risk evaluation.

In the first quarter of the year, revenue from trading derivatives doubled to $4.4 billion. Revenues from foreign exchange positions fell by $283 million to $1.7 billion; revenues from equity trading positions rose by $314 million to $888 million; and revenues from interest rate positions rose by $2.1 billion to $1.6 billion.

Joint indexes planned for Asian exchanges

Stock exchanges in Bangkok, Jakarta, Kuala Lumpur, Manila and Singapore will collaborate to set up joint indexes for derivatives and fund managers.

The five exchanges have signed a memorandum of understanding with FTSE Group on the creation of the planned Association of South East Asian Nations (Asean) equity indexes. Under the memorandum, FTSE will create indexes that could be used for benchmarking institutional and retail funds, exchange-traded funds and derivatives contracts.

The exchanges said in a joint statement: "This is the first collaborative effort among the five exchanges under the Asean umbrella, and we see this as paving the way for future collaborations between the exchanges. The development of indexes based on international standards and recognised methodology by FTSE will facilitate the international visibility of the Asean markets, and help promote the Asean economies to both regional and global investors by branding Asean as an asset class."

No launch date has been announced for the indexes.

Eurex to launch CDS index product

Eurex has licensed International Index Company's (IIC) European iTraxx indexes in preparation for the launch of an exchange-traded contract based on the European credit default swap (CDS) index before the end of the year. Eurex signed the exclusive licensing agreement on July 11, which covers the European iTraxx indexes. The Europe CDS index is based on a weighted portfolio of the 125 most liquid investment-grade European CDS.

Eurex says the launch of an exchange-traded CDS derivatives product would be "a major step in the shaping of the global credit derivatives market".

Rudolf Ferscha, chief executive of Eurex, says: "We are the first exchange to list credit derivatives products. We believe credit derivatives based on iTraxx indexes will meet investor demand for liquidity and transparency in the credit markets, and facilitate credit risk management at low cost."

David Mark, chief executive of IIC, adds: "The next phase of product design for a futures contract will be crucial to ensure wide interest. We expect that, following the recent launch of funded notes on iTraxx indexes, the coming credit derivatives futures contract will attract new participants to this dynamically growing market, thus adding further depth and liquidity."

IIC also collaborates with Dow Jones to produce Asian, Australian and Japanese CDS indexes

Task force formed on derivatives

Regulators in the US and the EU have set up a task force to help integrate regulated derivatives markets on each side of the Atlantic.

The Committee of European Securities Regulators and the US Commodity Futures Trading Commission named France, Germany, the Netherlands, the UK and the US to the task force. It will spend the next nine months determining a common set of requirements needed for firms to register to trade derivatives in both jurisdictions.

The next stage will be to simplify the rules on access to the derivatives market – a process that could take up to two years, the regulators say. The overall process has been given a three-year deadline.

Derivatives traders, asked to comment on the rules, highlight the importance of ensuring that regulations match in each jurisdiction to avoid regulatory arbitrage. There were also calls for the registration process to be speeded up by allowing online registration. The regulators singled out potential legalisation for moving operations to a transatlantic disaster recovery site, saying "this idea has great merit and is specially identified".

Tullett appoints new chief executive

Tullett Financial has changed its name following the merger with Prebon and named Andrea Danese as chief executive. The company will now be known as Tullett Prebon Information.

Danese, based in New York, joins Tullett Prebon Information from Creditex, where he was president and chief operating officer. Parent company Collins Stewart Tullett completed the takeover of Prebon in October 2004, in a transaction that gave the broker an enterprise value of £125.3 million, including debt and obligations. Collins Stewart Tullett paid £69.5 million in cash and shares for the company.

Geoff Chapman, chief information officer of the inter-dealer brokerage arm of Collins Stewart Tullett, says: "With the development of new industry regulations, there is greater demand for transparency within the financial services industry. Organisations like Tullett Prebon Information that can confidently provide secure independent market data and help customers ensure access to market information will be in even greater demand."

Deutsche Bank launches European ABS index

Deutsche Bank has launched a European AAA floating-rate securitised bond index. The index will capture the performance of the European asset- and mortgage-backed securities market and focuses on the largest and most liquid AAA component of euro-denominated floating-rate notes.

To be eligible for inclusion in the index, bonds must meet minimum tranche size thresholds and have a minimum average life of at least 13 months. The index includes only European floating-rate asset- and mortgage-backed debt. Daily levels on the index will be provided by Deutsche's ABS trading desk.

The launch comes roughly 18 months after Lehman Brothers rolled out its first European ABS index. Deutsche Bank estimates there was roughly €600 million of European securitised bonds outstanding as of mid-2005.

CFTC freezes hedge funds over alleged fraud

The US Commodity Futures Trading Commission (CFTC) has obtained a federal court freeze on the assets of a $230 million hedge fund following an investigation of the fund's operators for fraud.

The company's assets, and those of its president, Paul Eustace, have been frozen under the order, its records placed under guard and a receiver appointed to oversee the assets until the case comes to court.

According to a complaint filed by the CFTC, Philadelphia Alternative Asset Management and Eustace issued false statements to at least one investor stating that the fund had made gains trading commodity futures and options, and that the investor's account had increased in value to more than $1 million. In fact, the fund never actually traded futures or options, the CFTC claims.

The complaint also claims Eustace concocted fake trading records for two other pools to indicate profits on derivatives trading, when in fact the pools' derivatives accounts had lost 50% of their value. The pools had a total of over $230 million invested, the CFTC complaint says.

The case will come before the Pennsylvania Eastern District Court on August 16. The CFTC, backed by the National Futures Association, is seeking a permanent injunction against Eustace, the return of the money and a further fine. A district court in Ontario has also frozen Eustace's Canadian assets and bank accounts pending the court hearing. Eustace could not be contacted for comment.

Alexander Campbell

Isda backs Bear Stearns appeal

The International Swaps and Derivatives Association and the Bond Markets Association (BMA) have backed Bear Stearns' latest attempt to keep hold of $25.9 million in payments on a stock forward agreement in the face of Enron's attempt to recover it.

Enron entered the one-year forward for 323,000 of its own shares in May 2000 and settled in August 2001, paying $25.9 million for the shares. Just over three months later, on December 2, Enron filed for Chapter 11 bankruptcy protection.

As part of the bankruptcy process, Enron filed suits in 2003 against Bear Stearns and three other banks – Credit Suisse First Boston, Lehman Brothers and UBS – asking for the return of payments made in 2001 in connection with derivatives trades. Enron's argument was that it was already insolvent – although not in Chapter 11 – when the payments were made.

Bear Stearns and the other banks, backed by both Isda and the BMA, argued that the payments were protected by the safe harbour provisions of the US bankruptcy code. They warn that allowing Enron to claw back the payments could lead to the disruption of the financial markets.

However, when the original suit reached the New York Southern District bankruptcy court in April this year, the court ruled in Enron's favour, blocking a motion to dismiss filed by Bear Stearns. The US firm, with support from Isda and the BMA, is now seeking an appeal against the decision.

In the filing, Isda warns that "the bankruptcy court's ruling effectively eviscerates the safeguards", and adds that the opinion, if left unreviewed, would "chill the financial markets, exactly the outcome Congress intended to prevent".

Alexander Campbell

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