US Treasury tells derivatives managers to improve Risk practices

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David Benyon
27 Sep 2007

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Washington – Investors in higher risk derivatives products are under increasing scrutiny, the US Treasury has warned. The president’s working committee on financial markets is investigating the impact of securitization and the role of ratings agencies in credit and mortgage markets on recent financial crisis. A committee of hedge fund managers and another of investors are to develop new best practice standards to improve investor protection and systemic risk safeguards. Current “unhealthy” investment practices by some involved in the complex, securitised products are held partly responsible for the current crisis by Russell Read, leading the investment committee. Read is also chief investment officer of the California Public Employees Retirement System.

Due diligence prior to investment decision-making marks the difference between investors and gamblers, according to Anthony Ryan, the US Treasury’s assistant secretary for financial markets, speaking to an International Swaps and Derivatives Association (ISDA)conference in New York. He stressed that through market discipline – rather than regulation – investors could lessen the probability and the effect of systemic events.

Central banks have already been deciding their responses to the threat posed by this month’s credit drought. Much of the illiquidity, with banks apprehensive to lend until hidden losses are unearthed from further down the investment chain, has been blamed on inadequate transparency. Tasked with defining and fixing the sources of the transparency problem, Eric Mindich, Chief executive officer of Eton Park Capital Management, leads the hedge fund managers committee. Mindich said that “transparency is something everybody is for but nobody can define”. His counterpart Russell Read, on the investors committee, said that the key to more openness did not lie in more information on the specific investments or transactions, but about the types and amounts of risk involved.

There was praise for the great benefits brought by the creation of innovative credit derivatives and for the market’s recent headway in reducing backlogs of orders, clearing and settlement, but the treasury’s committees say there is collectively much more to do.