Counterparty credit concerns

Regulators are getting interested in derivatives counterparty credit risk. When Federal Reserve chairman Alan Greenspan noted in May that one dealer (and we understand this to be JP Morgan Chase) accounted for a third of the global dollar interest rate options and credit default swaps markets, he was thinking primarily of the risk management implications. According to Greenspan: “Concentration of market-making has the potential to create concentrations of credit risks between the dealers and the end-users of derivatives, as well as between the dealers themselves.”

Despite such regulatory interest, however, the new Basel Accord will not affect capital requirements for derivatives counterparty credit risk. In particular, the old ‘add-on’ approach of calculating fixed loan-equivalent exposures by adding notional percentages for individual transactions on to mark-to-market values will stay in place. This approach has been criticised by leading financial institutions, which have lobbied for a capital treatment that reflects their own best practice