(Recasts, adds details, context)
NAPLES, Florida Jan 29 Reforming the $450
trillion derivatives market is key to removing the risks of
financial markets, and greater central clearing of privately
traded derivatives is a vital part of that, the head of the
Commodities Futures Trading Commission said on Friday.
Central clearing, in which a counterparty stands between
two trading partners and guarantees the trade, is needed to
remove risks from banks, Gary Gensler, chairman of the CFTC,
said at a conference hosted by the American Bar Association in
Naples, Florida. He also called for greater transparency.
Banks are at greater risk of failure than exchanges because
they also have large lending and trading operations.
Derivatives, which are based on underlying assets including
bonds and commodities or can be tied to currency and interest
rate moves, have been blamed for exacerbating the credit crisis
and contributing to a run on assets that helped fell banks
including Lehman Brothers.
And insurer American International Group's (AIG.N) outsized
exposure to risky assets using credit default swaps, which are
used to insure against a debt default, led to its need for a
massive government bailout.
Lawmakers internationally are developing rules to regulate
the markets, move standardized contracts to central
counterparties, and limit positions taken on by large market
Gensler said that proposals to exempt from central clearing
certain end users of derivatives must be very narrowly defined
to ensure the majority of the risk does not remain with large
banks. End users include industrial companies that use
derivatives contracts to protect against interest rate,
currency, commodity and other risks.
Data from the Bank for International Settlements shows that
only around 40 percent of derivatives volumes are made between
the largest dealers, indicating that 60 percent of the market
could potentially be exempted from clearing requirements,
Financial companies including insurers and hedge funds,
also should not be exempt from central clearing, as they should
be sufficiently liquid to meet the margin requirements of
central counterparties, Gensler said.
Some industrial companies have said that mandating central
clearing of their positions would add significant costs to
their business due to the requirement to post margin against
the trades, which bank counterparties do not always require.
Transparency of derivatives contracts is also key to
reforming derivatives markets, Gensler said.
"I believe that financial reform would be incomplete if we
do not bring public transparency to the over-the-counter
derivative marketplace," he said.
Transparency, in which trade prices can be seen through
exchanges or other electronic trading platforms, enhances
market liquidity and creates a more competitive marketplace by
bringing in new players, which in turn reduces trading costs,
The move would shift the advantage of price and trading
information from the large dealers to the end users, Gensler
Transparency should be also be required for contracts that
are not centrally cleared, he said, adding, "Commercial end
users are concerned about the cost of clearing, but there is
not a cost to transparency."
Technology exists that would allow derivatives users to use
electronic platforms to receive quotes form numerous
counterparties, and choose the best price to execute on, he
(Reporting by Karen Brettell; Editing by Leslie Adler)