Industry group warns of risk of derivatives crisis

The derivatives industry urgently needs to improve its transaction handling and risk transparency if it is to avoid a crisis, an industry taskforce said yesterday.

The Counterparty Risk Management Policy Group was set up to help ward off another shock to the financial markets after the collapse of Long Term Capital Management and the Asian and Russian financial crises in 1998. In its second report, published yesterday, it warned that the backlog of unsigned confirmations is a system-wide problem that needed solving "as a matter of urgency”.

Although institutions are already spending substantial amounts on the problem, more effort is needed, the report said. The group added that management should cut back trading volumes if necessary until the backlog was brought to a manageable level.

The group, led by Goldman Sachs managing director Gerald Corrigan, also called for more spending on back office IT to speed up settlement of credit derivative transactions, and warned that reassigning transactions without the counterparty's consent made it very difficult for counterparties to monitor their exposure.

Hedge funds also came under particular scrutiny: the group called for the funds to report large exposures to regulators, either directly or through other already-regulated institutions.

Summarising the situation of the market, the group said that the likelihood of another LTCM-type shock to the market had fallen. However, it added that the growing complexity, speed and connectivity of the global market made monitoring far more difficult and meant that another crisis could spread faster around the world.