NY Fed to push ahead with CDS market regulation

By Ciara Linnane and Karen Brettell

NEW YORK, Oct 6 (Reuters) - The New York Federal Reserve said on Monday it is planning to meet with small banks and institutional investors to discuss establishing a central counterparty for the credit default swap market.

Politicians and regulators have been clamoring for regulation of the $55 trillion over-the-counter market, which has been widely blamed for some of the financial sector's recent problems.

CNBC reported that the Fed is planning talks with the Chicago Mercantile Exchange and the Intercontinental Exchange, or ICE.

The collapse of major counterparty Lehman Brothers (LEHMQ.PK) last month brought fresh urgency to the calls for rules to improve transparency and safety.

Credit default swaps, or CDS, are used to protect against the risk that a borrower will default on its debt, or to speculate on its credit quality.

Critics charge that the rapid growth of the CDS market helped fuel demand for banks to extend loans to people unable to repay their mortgages. They then distributed those loans globally, exacerbating systemic risk when contracts failed.

Massachusetts Democratic Rep. Barney Frank said Monday he believes the lack of regulation of CDS was behind the recent financial crisis. Congress on Friday approved a $700 billion government package to bail out the U.S. financial system.

"We have to step in and impose regulations that will not allow this to happen again," said Frank, who is head of the House Financial Services Committee. See [ID:nN06387796]

It is not yet clear what form a New York Fed-backed central counterparty might take, although a number of initiatives are underway to create a clearing house for swaps.

Clearing Corp, a dealer-owned clearing house, expects to have the required regulatory approvals and systems in place to launch a clearing platform for U.S. and European CDS by the end of the year.

Separately, the Chicago Mercantile Exchange "can be operationally ready to clear CDS in a few weeks," according to a spokesperson.

NYSE Euronext's Liffe unit has said it will launch its BClear OTC facility based on the benchmark European credit derivative indexes in the fourth quarter.

NY STATE PLANS TO ACT

New York State authorities recently said they too are working on a clearing house as part of a broader plan to start regulating the CDS market from January 2009.

New York Gov. David Paterson has said the state will start regulating CDS contracts that can be classified as insurance. He estimated these contracts form 20-25 percent of the market.