Wednesday, January 7, 2009

EU Threatens Credit-Swap Law as Clearing Deal Falters

(Bloomberg) The European Union revived its threat to regulate credit-default swaps after banks backed away from last month’s agreement to process trades through a clearinghouse in the region.

“There’s just not sufficient commitment,” Oliver Drewes, spokesman for EU Financial Services Commissioner Charlie McCreevy, said today by telephone. “McCreevy will therefore have to consider the appropriate next steps.”

McCreevy pushed industry groups and regulators into a tentative agreement Dec. 10 in Brussels to clear the bilateral, privately negotiated transactions through a central counterparty that would help absorb losses if a dealer failed. The plan, similar to actions in the U.S., comes after the September collapse of Lehman Brothers Holdings Inc., which was among the largest credit swaps dealers.

Credit swaps dealers remain at odds with the EU’s demand to use a clearinghouse within the 27-nation area to ensure European regulators will be able to oversee the business. While committing to clear trades linked to European entities through a central counterparty, dealers have urged regulators globally to coordinate their oversight of the market.

‘Common Regulatory Framework’

Eight banks including JPMorgan Chase & Co., Goldman Sachs Group Inc., UBS AG and Deutsche Bank AG said in a letter to McCreevy last month the group would encourage “a common regulatory framework” for oversight of the global credit swaps market. The letter was circulated to members of the International Swaps and Derivatives Association or ISDA.

Brian Marchiony, a spokesman for JPMorgan, Goldman Sachs spokesman Michael DuVally, UBS spokeswoman Kelly Smith and Deutsche Bank spokeswoman Michele Allison declined to comment.

Drewes declined to say what action the European Commission, the EU executive agency where McCreevy oversees financial services, may take. Any regulatory proposal would need to be approved by EU lawmakers and national governments.

Dealers are committed to clearing the trades through a central counterparty to alleviate risks, ISDA said today.

“The industry has now made the same commitment to regulators in both the EU and the U.S. to proceed with a clearing solution for CDS,” the association said in an e-mailed statement. “We are committed to continuing to work with regulators on both sides of the Atlantic as we move forward with developing risk-management solutions that meet regulatory needs on a global basis.”

Awaiting Approval

Nine of the largest credit swaps dealers have backed a plan by Atlanta-based Intercontinental Exchange Inc. to clear trades. That clearinghouse is awaiting approval by U.S. regulators. NYSE Euronext’s Liffe derivatives market said it opened a clearinghouse last month to guarantee European index contracts, and Chicago-based CME Group Inc. received approval from the U.S. Commodity Futures Trading Commission on Dec. 23 to guarantee credit swaps with its clearinghouse. Eurex AG also is planning to clear trades.

Credit swaps are used to hedge against the risk of a borrower defaulting, or to speculate on a borrower’s creditworthiness.

“A European regulator should be concerned about an overseas clearinghouse putting the funds of European institutions and customers in an inaccessible form at a time of default or trouble,” said Bruce Weber, a professor at the London Business School specializing in exchanges and trading systems.

Cost Issue

To dealers, “this looks like a cost issue from which they don’t benefit,” Weber said in a telephone interview. “The budgets in these banks are so tight they are squeezing every single expense item down.”

A lack of progress on clearing efforts may be hurting credit-default swap trading volumes, said Brian Yelvington, a strategist at CreditSights Inc. in New York and a former credit- swaps trader.

“Clients are telling us they are reticent to participate in a market in this much transition,” he said. With actual company bonds yielding more and the ability to fund those purchases improving, “the dealers are likely missing some CDS flow,” Yelvington said.

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