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Clementi warns on derivatives
By Aline van Duyn
Published: March 12 2001 00:47GMT | Last Updated: March 12 2001 00:47GMT
The growing use of credit derivatives by banks to reduce their risk of exposure to defaults by companies could jeopardise the stability of financial markets, according to the Bank of England.
David Clementi, deputy governor at the Bank of England, said on Friday he was concerned about the lack of transparency in credit derivatives, making it difficult for bank creditors, shareholders and regulators to assess the risks of exposure to particular companies or sectors.
He also said there were legal uncertainties in the use of credit derivative contracts and documentation in the market had to improve to keep pace with the growing levels of transactions.
"In a wider sense, the development of these markets for the transfer of credit risk is highly desirable," Mr Clementi said in a speech delivered in Rome.
"Unfortunately, however, where there is innovation, there are generally concerns . . . From the point of view of financial stability, the concern is that these instruments might equally be used to concentrate risk as to disperse it."
The credit derivatives market has grown rapidly. A survey by the British Bankers' Association in July of last year estimated the market had grown more than three times since 1997 to outstandings of about $600bn. Mr Clementi said market participants' estimates go up to a $1,000bn.
Banks or investors can buy the contracts from another party.
In the event of a default by the company, the contract will pay compensation. This should allow banks to reduce the risks of default, without actually removing the assets from their balance sheets.
The uncertainties in the market were highlighted last week after UBS filed a suit in the UK against Deutsche Bank for more than $10m over a credit derivative related to Armstrong World Industries, a US building materials company.
Mr Clementi said that, if they work well, credit derivatives can enhance financial stability, but authorities had to work with the market to make sure this was achieved. |
