UPDATE 2-Legal changes needed to enhance CDS protections
(Adds details, rewrites throughout)
NEW YORK, July 13 (Reuters) - Large dealers and fund managers in the $26.5 trillion credit default swap market have proposed regulatory changes in the U.S. and Europe to protect client funds backing credit default swaps in central clearinghouses, the New York Federal Reserve said on Monday.
Market participants conducted a study at the request of the New York Fed to determine how easily client funds backing CDS trades could be retrieved or transferred to a new clearinghouse member, should a member of any of the six clearinghouses vying for business in the U.S. or Europe default.
"In both the U.S. and Europe, a wide range of legislative reforms could be implemented to enhance the protection of customer margin, and increase the likelihood that such margin will be successfully transferred or returned to customers," the report released by the Fed found.
The Obama administration is pushing for all "standardized" credit derivatives to be centrally cleared after some clients lost assets backing derivative trades they held with Lehman Brothers when the bank collapsed in September 2008.
Collateral, which may include cash or securities, is posted against derivatives to reduce losses if a counterparty to the trade collapses.
Bank and investor fears that they would lose assets backing derivatives led to runs on Lehman and Bear Stearns, which hastened their demise.
Among those clearing houses examined in the study were the IntercontinentalExchange Inc (ICE.N), which has a revenue sharing agreement with large CDS dealers for its clearing arm, and the CME Group Inc (CME.O), which has a joint venture with hedge fund Citadel Investment Group.
ICE is the only clearinghouse to have started clearing CDS, and has cleared $1.3 trillion in notional volumes on CDS indexes.
Other clearinghouses evaluated in the study include those operated by NYSE Euronext (NYX.N), London-based LCH.Clearnet, Frankfurt-based Deutsche Boerse (DB1Gn.DE) and German/Swiss exchange Eurex.
Dealers involved in the study included Barclays Capital (BARC.L), JPMorgan (JPM.N) and Goldman Sachs (GS.N), while asset managers involved included AllianceBernstein, DE Shaw Group and PIMCO.
PROPOSALS
The 153-page study proposed that rules be introduced to clarify how margins backing CDSs are treated when a clearinghouse member defaults.
Clarity about the ability of a clearinghouse to reuse some CDS collateral without clients losing their proprietary interest in the assets, and laws protecting clients against the risk of a clearinghouse failing to segregate assets, were also recommended.
The study found that the type of collateral posted against client trades can have a large impact on the ease to which it may be reclaimed or transferred if a member of a clearinghouse defaults. Continued...
