UPDATE 2-NY Federal Reserve pushes for central CDS counterparty

(Adds comment from Nasdaq)

By Ciara Linnane and Karen Brettell

NEW YORK, Oct 6 (Reuters) - The New York Federal Reserve will host a meeting with banks and institutional investors on Tuesday to discuss establishing a central counterparty for the global credit default swap market.

Politicians and regulators have clamored for improved oversight of the $55 trillion over-the-counter market, widely blamed for some of the financial sector's recent problems.

Industry players agreed with the Fed and other regulators in July that a "robust central clearing infrastructure" is needed for OTC credit derivatives, the Fed said.

"This will help reduce systemic risk associated with counterparty credit exposure and improve how the failure of a major participant would be addressed," it said.

The statement came after U.S. business television channel CNBC reported the Fed was planning talks with the Chicago Mercantile Exchange, or CME, and the Intercontinental Exchange, or ICE, on the creation of a CDS exchange. The companies declined to confirm the report, although they said they would be willing to participate in any initiative.

"Serious concerns are now emerging about the ability of counterparties of these contracts to actually meet their performance obligations," CME Chief Executive Craig Donohue told the Council of Institutional Investors Fall conference.

"There's clearly a lack of confidence in the functioning of that market," he said.

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.

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

Joseph Mecane, executive vice president and chief administrative officer for U.S. Markets at NYSE Euronext, told Reuters a CDS exchange is "inevitable."

"The biggest issue is counter-party risk, and a central counterparty will solve that," he said. "There could be competing exchanges with a central clearing house, like in equity markets."

CLEARING THE DECK

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