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Strategies & Market Trends : John Pitera's Market Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: John Pitera who wrote (7188)	9/15/2005 12:51:39 PM
From: John Pitera	Read Replies (3) \| Respond to of 33421

I am pretty sure that the problems with credit default derivatives especially the inability to accurately assess counter-party risk and counter party solvency are going to be a major factor in the next financial system blow up. The timing of this will probably coincide with an upcoming quick 275- 300 basis point sprint in the 10 year yield. The bottom line is that with the daisy chaining of these sales and resales of the credit default protection contracts. Some players will end up overextended and unable to cover their default exposures. The Valuation issue begs for misuse and future litigation as hedge fund managers etc get sued for overstating the value of their contracts and getting paid 20 % of the inflated estimated value. John

To: John Pitera who wrote (7188)	9/15/2005 6:01:41 PM
From: John Pitera	Read Replies (1) \| Respond to of 33421

The FT reports that next week, the Federal Reserve Bank of New York will host an unusual gathering of 14 investment banks and their regulators. Timothy Geithner, president of the New York Fed, summoned the banks for a discussion of "important" issues in the fast-growing credit derivatives market. The New York Fed speaks often with the banks it regulates, but the last such visible meeting occurred in 1998 – amid near-panic in the financial markets – as regulators scrambled to avert the collapse of Long-Term Capital Management, the US hedge fund. Nobody is suggesting a meltdown is imminent this time. Brad Hintz, a securities industry analyst at Sanford Bernstein, said the move was a "natural response" by the New York Fed to market developments. "With credit derivatives trading volumes doubling annually for the past five years, the infrastructure that settles those trades has been taxed and needs attention. This is merely a case of the Fed doing its job," he said. Nonetheless, any pointers from the September 15 meeting will be watched by banks around the world. For example, the New York Fed could push credit derivatives dealers to standardise trading documentation and invest more in technology. That would echo a report published in July by a financial industry group led by Gerald Corrigan, a former president of the New York Fed who is now a managing director at Goldman Sachs. "We expressed some sense of genuine urgency," Mr Corrigan told the Financial Times. "It's a classic example of a situation in which the official community and the private sector should be and are working together." Banks face two broad challenges, says Mr Corrigan. First, they have to deal with existing backlogs. Then, they have to ensure future trades are processed automatically so a backlog does not build up again. The first of these efforts demands what he called a "three yards and a cloud of dust" approach, referring to a gritty, unglamorous American football strategy. Dealer banks and their clients simply have to comb through records to ensure their systems are up to date. That sounds straightforward, and banks and industry bodies insist they are making progress. "The average time [to settle] credit derivatives reduced significantly from 17.8 [days] at end 2003 to 13.3 at the end of 2004," said Robert Pickel, chief executive of the International Swaps and Derivatives Association, suggesting the proportion of delayed trades was shrinking. But the speed of market growth makes it hard to keep up with existing orders, let alone deal with the backlog as well. "Some banks say they almost wish that the market could be closed for a month, just so they could catch up," said one international finance official. Getting up to date with historical trades is only one part of the battle. For new trades, the goal is full automation – or "straight-through processing". That objective has spawned a rash of technological initiatives. For example, the Depository Trust and Clearing Corporation – which settles most stock and bond transactions in the US – recently expanded its credit derivatives capability. A new start-up, T Zero, aims to improve the electronic transfer of trade information between systems. Meanwhile, MarketAxess and TradeWeb, rival electronic bond trading businesses, both said they planned to launch credit default swaps trading in the coming weeks. "Automation of confirmation generation also improved significantly [between 2003 and 2004] from 24 per cent to 40 per cent," said Mr Pickel at ISDA. For several years, the organisation has been developing standardised documentation for derivatives trades – a prerequisite for automation. The next challenge, which ISDA calls its "No.1 one priority", is to standardise assignments of credit derivatives trades. A bank and a customer may initially agree a trade. But later, the customer could decide to sell a position to a different bank. Such an assignment requires all three parties to agree – inviting delays and errors. ISDA is working on a protocol to simplify assignments. Unusually, it is consulting fund manager groups as well as banks in an effort to satisfy all market participants. The move reflects the significance of hedge funds in the credit derivatives markets – and the fact that their requirements sometimes differ from those of the big Wall Street dealers. That protocol should be released before next week's meeting at the New York Fed, and Mr Corrigan thinks a commitment to adopt it could be one outcome. "I would imagine one of the things discussed at some length is [likely to be] a reasonable timescale to implement the new ISDA protocol to govern assignments," he said. finfacts.com