Paulson lauds NY Fed steps to cut derivative risk

By Joanne Morrison

WASHINGTON (Reuters) - Treasury Secretary Henry Paulson on Thursday lauded efforts by top derivatives players and the New York Federal Reserve Bank to improve transparency and reduce credit risk in the massive $62 trillion credit default swaps markets.

"I am pleased that a number of the institutions that account for a significant percentage of OTC derivatives trading are working to do this, by recently forming a cooperative and working with the New York Fed, under Tim Geithner's leadership, to create the necessary protocols to bring more transparency and efficiency and reduce counterparty credit risk," Paulson said in a speech here to a women's financial group.

His comments came after New York Federal Reserve Bank President Tim Geithner last week held meetings with a group of firms representing about 90 percent of credit derivatives trading.

Key to those meetings is a plan to develop a centralized clearinghouse, one that is owned and operated by and among the firms that have been meeting with the central banker.

Those involved in the clearinghouse plan include: Goldman Sachs (GS.N), Citigroup (C.N), Deutsche Bank (DBKGn.DE), JPMorgan Chase (JPM.N), UBS (UBSN.VX), Credit Suisse (CSGN.VX), Merrill Lynch MER.N and Bank of America (BAC.N).

"It is imperative that this cooperative bring standardization not only to dealer transactions but to the broader community of counterparties, including hedge funds," Paulson said.

Some critics warn that there are risks in creating a swaps clearinghouse because such a system would place credit risk for this massive market into one entity.

A clearinghouse differs from an exchange trading system because it is used to transfer and centralize credit risk. A trading system would offer an exchange-like environment, with price transparency but without typically transferring credit risk from the parties involved in the private derivative transaction.

(Reporting By Joanne Morrison; Editing by Tom Hals)