Central banks seek more data on credit derivatives

The Bank for International Settlements (BIS) is going to ask dealers in the credit derivatives market to supply more information about their business, including information on who they are dealing with.

The 61 dealing firms that currently report semi-annually to the BIS on their activity in over-the-counter derivatives already reveal their net outstanding positions in OTC interest rate, foreign exchange, equity and commodity derivatives. These positions, say the BIS, totalled just over $197 trillion at the end of 2003.

The December 2004 semi-annual survey by the BIS, scheduled for release in May next year, will in addition cover the fast-growing credit derivatives business, focusing on credit default swaps. The survey will also break new ground by asking respondents to identify the kind of counterparty they are dealing with, distinguishing between banks, insurance companies (including a special category for specialist monoline insurers) and other investors, including hedge funds. Dealers will also be asked about the maturity and the geographic breakdown of their credit derivatives books.

Central banking sources describe the new information requests as “a useful expansion of the publicly available information on credit default swaps”.

However, the initiative stops short of asking banks for a similar level of disclosure on the collateralised debt obligation (CDO) business because the complexity of CDO trading made that impractical.

According to the International Swaps and Derivatives Association, the credit derivatives business (comprising credit default swaps, baskets and portfolio transactions) had grown to $3.58 trillion by the end of 2003 – a 29% growth on the year. A study by consultancy firm McKinsey, conducted on behalf of Deutsche Bank last year, forecast that the credit derivatives business could grow to as much as $10 trillion by 2007, with the number of actively traded credit default swaps set to double by 2007 to 600. Growth would be driven by demand from banks seeking to lay off the risk of their corporate loans.

Fuller disclosure

In the past, regulators have flagged their concern that this burgeoning market for credit risk transfer might lead to a concentration of risk among end-users of credit derivatives. A move to fuller disclosure of risk transfer from banks to other financial institutions has been on the agenda of the Committee of the Global Financial System, one of the permanent committees that meets under the auspices of the BIS.

The withdrawal of some insurance companies, such as Scor, the French reinsurer, from underwriting credit derivatives has assuaged some of those fears. But regulators say they still want to know more about how credit markets might respond to liquidity problems, especially because two banks – JP Morgan Chase and Deutsche Bank – are known to have particularly large credit derivatives books.

“Concentration is an issue,” says Alastair Clark, adviser to the governor of the Bank of England. “Not so much in terms of the exposures of the major dealers, which are relatively small when netting and collateral agreements are taken into account, but because of the reliance on a small number of firms for market liquidity.”

Not surprisingly, credit derivatives dealers insist they have succeeded in reducing risk with credit derivatives, rather than increased it. Speaking at a recent Risk conference, Rajiv Misra, Deutsche Bank’s head of credit trading, claimed commercial banks have reduced the proportion of the financial markets’ credit risk they hold from between 70% and 75% to between 40% and 45% through credit derivatives.

But Misra also conceded that Deutsche Bank was reluctant to warehouse credit risk because of the danger of “credit gaps” – sudden and exaggerated price moves that happen more often in the credit markets than other markets. “Relative value is a better way to play the market,” he said.

However, if regulators and supervisors have been reassured by these comments, they still want to know more about where the risk is transferred to, and who exactly is doing that transferring.

The credit derivatives books of some European banks, including BNP Paribas, Société Générale, Commerzbank and Dresdner Bank, have been growing rapidly over the past year, and both the Banque de France and the Bundesbank are reported to be keen to improve their flow of information on credit derivatives dealing.

When it is released, the new BIS survey data on credit default swap trading will not disclose the positions of individual dealers, but it will allow regulators to state just how much business is concentrated in how many hands.

Risk