New regulation for credit default swaps

Chairman of the House Agriculture Committee Collin C. Peterson (D-Minn.) thinks that credit default swaps (CDS) played an important part in the current economic crisis.

“[Few] people know the significant role they have played in the financial and credit crisis that has threatened the stability of our economy,” said Peterson during his committee’s hearing on reviewing the role of credit derivatives in the U.S. economy.

“The sudden collapse and gradual fallout of the insurance giant AIG and the difficulties experienced by other financial firms in recent months have served to demonstrate that the CDS market is extremely opaque and that market positions, as a result, are nearly impossible to value during times of stress.”

To confront these concerns over lack of transparency, attempts have been made to find regulatory solutions for CDS markets. Last week the Federal Reserve System, the Securities Exchange Committee, the Commodity Futures Trading Commission (CFTC), and the Treasury Department signed a memorandum of understanding that would establish a clearing house for CDS which would be under the signers cooperative oversight.

“Financial institutions need to make changes in their risk management practices for [over the counter] derivatives by improving internal incentives and controls and by ensuring that traditional credit-risk management disciplines are in place for complex products, regardless of whether they take the form of CDS or of securities,” said Patrick M. Parkinson, Deputy Director of the Division of Research and Statistics Board of Governors of the Federal Reserve System.

“The Federal Reserve is working cooperatively with other domestic and international authorities to strengthen the infrastructure through which CDS trades are cleared and settled and to address weaknesses that have been identified in the risk-management practices of major market participants.”

Anada Radhakrishnan, Director of the Division of Clearing and Intermediary Oversight of the CFTC discussed the expertise the commission would bring.

“The CFTC has developed extensive institutional knowledge and regulatory expertise regarding derivatives clearing…we at the CFTC will continue to work collaboratively and cooperatively with our colleagues…to bring transparency and financial integrity to the CDS market through clearing and infrastructure improvements.”