Geithner's derivatives plan welcomed as overdue

NEW YORK (Reuters) - The U.S. Treasury's plan to tighten up on derivatives such as credit default swaps -- effectively throwing its weight behind a shift well under way among exchanges and financial players -- was applauded as long overdue on Thursday by industry observers.

Treasury Secretary Timothy Geithner, testifying to Congress on Thursday, said a comprehensive framework was needed to protect markets from risky derivatives, arguing more of them should be funneled through clearinghouses and exchanges.

He highlighted CDS as products that should no longer pose a threat to the stability of global markets simply because a handful of big institutions made reckless bets.

With the industry braced for regulatory changes amid the wider credit crisis, market participants said the government's strong backing for a major shift in the way securities are traded was overdue.

"The industry recognized that need and was headed in that direction," said Larry Eiben, chief operating officer and co-portfolio manager at mutual fund TFS Capital, which manages $560 million.

"CDS is one of those things where it doesn't take much capital to play that game," he said. "Clearly, we need modern regulation for modern times and I think any product that is that substantial to the marketplace should be regulated."

John Jay, senior analyst at consultancy Aite Group, said: "Such measures should have been expected anyway. Now it's just official."

The market for CDS, which insure against debt default, was born earlier this decade and exploded to a notional value of about $62 trillion at the beginning of last year.

The highly interconnected market is now worth about $28 trillion, and U.S. and European regulators have said since the fall it needs one or more central counterparties to ensure the default of one player does not threaten others.

"The days when a major insurance company could bet the house on credit default swaps with no one watching and no credible backing to protect the company or taxpayers from losses must end," Geithner said in Washington, alluding to collapsed U.S. insurer American International Group Inc.

He added that more standardized products that now trade in the private OTC market require a clearinghouse and that more should be traded on a transparent exchange.

"Not only did he encourage central clearing, but he encouraged exchange trading. Up until now, that has been the piece that's missing," said Gary DeWaal, group general counsel at brokerage Newedge.

Robert McWilliam, vice president of derivative trading at asset manager T. Rowe Price, said: "He's telling Congress basically where the market is already going. He's not saying anything new."

U.S. exchange operators IntercontinentalExchange Inc and CME Group Inc have already built U.S. CDS clearinghouses. ICE's launched earlier this month while CME, which also plans a CDS exchange, says its will launch soon.

The exchanges, which would act as counterparty for each CDS trade, say their clearinghouses will protect against cascading defaults that worry market participants and regulators alike.

"For the majority of the liquid CDS products, index products, tranches and single names, they fit quite neatly into a clearing house," said Jamie Cawley, chief executive at CDS broker IDX Capital.

Geithner said a new systemic risk regulator will require firms whose collapse could post a risk to the entire financial system to hold more capital than other financial companies and would face tougher rules.

(Reporting by Jonathan Spicer; Additional reporting by Karen Brettell; Editing by Gary Hill and Andre Grenon)