FSA retreats on insurer credit risk transfer concerns

The UK’s Financial Services Authority today said it generally has faith in insurers that use credit derivatives as a means for risk transfer. This contradicts previous statements by FSA chairman Howard Davies, who signalled his desire to clamp down on the securitisation and credit derivatives market back in January this year.

At the time, Davies noted how one investment banker described synthetic collateralised debt obligations to him as “the most toxic element of the financial markets today".The new FSA research, which some dealers predicted would tighten credit derivatives regulation, shows that risk transfer, although complex, can reduce the impact of economic downturns. The FSA also found that the most important driving force behind the transfers of risk across sectors of the financial markets has become the different risk appetites of the firms involved, rather than regulatory arbitrage.

“It has been said that insurance companies have taken on a lot of risk using credit risk transfers. In fact, we found that some firms, including UK and overseas insurance companies, only dabbled in the market and have now left it,” said Clive Briault, head of the FSA’s prudential standards division. “The most active participants appear to have developed a good understanding of the products, but care is still needed in the management of these new, innovative and complex products.”

The FSA will, however, continue to monitor cross-sector risk transfers to identify the growth of the market, now worth around $400 billion annually, with half of all trades done in London.

In his January comments, Davies warned that the FSA was concerned some insurance companies may not be pricing credit risks appropriately.

The International Swaps and Derivatives Association (Isda)today welcomed the FSA findings and will provide the FSA with more formal feedback regarding the entire discussion paper during the comment period. "Isda broadly supports the conclusions reached by the FSA regarding the need for senior management scrutiny of risk transfer activities and for the use of appropriate risk management systems," said Emmanuelle Sebton, Isda's head of risk management.