Regulators One Step Behind on Derivatives

By Sheehan, Brendan | Global Finance, June 2004 | Go to article overview
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Regulators One Step Behind on Derivatives

Sheehan, Brendan, Global Finance

The expansion of the investor pool and the rapid growth in the number and variety of credit derivatives available are prompting calls for stricter regulations.

As the race to list the first credit contracts on the world's flnancial exchanges intensifies, regulators are under increasing pressure to impose tighter constraints on the market. While one of the main challenges for the exchanges and their partners will be defining the specifications of the contracts, a bigger concern is the risk that investors will be taking. The much publicized corporate failures of the past few years have only added to the general awareness of the risks involved in credit derivatives, many of which arc still only partially understood by all but n handful of major players.

Some of the more significant advances in terms of regulation have been the work of the International Swaps and Derivatives Association. ISDA established standardized Master Service Agreements for credit derivative contracts and now operates in 39 countries. Prompted by the need to improve legal documentation for derivatives trades, the ISDA established exact definitions of a forward asset, what constitutes a "credit event" or default, and limits to size and duration of transactions.

Unfortunately, many trades are cross-border, and a number of national regulators are concerned that the ISDA rules are inadequate. They are looking into creating their own rules, triggering concern among the major banks that these groups will lag behind the market, resulting in rules that are out of date before they are even implemented.

Investor Base Grows

Credit derivatives have only recently attracted the attention of national regulatory bodies. This is mostly because the market was traditionally the almost exclusive realm of the major investment banks, and the number of credits was small.

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