Derivatives market trades on Sunday to cut Lehman risk

NEW YORK (Reuters) - Major players in the $455 trillion global derivatives market rushed Sunday to scale back exposure to a potential bankruptcy filing by investment bank Lehman Brothers in a rare emergency trading session.

Trading took place as U.S. regulators and bankers were making last-ditch efforts to prevent toxic assets from ailing Lehman Brothers LEH.N spilling into global markets and rupturing investor faith in the international financial system.

"This is an extremely, and I stress extremely, rare event. It also speaks to the more general notion that, in today's highly disrupted financial markets, the unthinkable is thinkable," said Mohamed El-Erian, the chief executive of Pimco, the world's biggest bond fund, based in Newport Beach, California.

The session opened at 2 p.m. New York time and was due to run until 4 p.m. (1800 to 2000 GMT), according to the International Swaps and Derivatives Association. ISDA later extended it for another two hours and some banks continued to offset their Lehman exposure even after the official session ended, according to a market source.

Trading involved credit, equity, rates, foreign exchange and commodity derivatives. ISDA estimates the OTC derivatives market excluding commodities has a value of $455 trillion.

Market sources said the special session was initiated by the Federal Reserve.

The aim is to reduce risk associated with a potential bankruptcy filing by Lehman Brothers Holdings Inc.

"Trades are contingent on a bankruptcy filing at or before 11:59 p.m. New York time Sunday (0359 GMT)," said the statement. "If there is no filing, the trades cease to exist."

LEHMAN DEAL HOPES FADE

Britain's Barclays Plc (BARC.L), which had appeared to be the frontrunner to take over Lehman -- excluding its bad mortgage-related assets -- pulled out of the bidding early in the afternoon, according to a person familiar with the matter.

Bank of America, which had also been named as a potential acquirer, was in advanced talks to buy Merrill Lynch & Co Inc MER.N for at least $38.25 billion in stock, the New York Times said on Sunday, citing people briefed on the negotiations.

Merrill Chief Executive John Thain and Bank of America (BAC.N) Chief Executive Kenneth Lewis were present at weekend talks on the future of Lehman.

Fading hopes for a Lehman deal raised the risk the firm may file for bankruptcy. Lehman hired law firm Weil Gotshal & Manges to prepare a potential bankruptcy filing, the Wall Street Journal reported on Saturday in its online edition, citing a person familiar with the matter.

The head of bond fund Pimco, Bill Gross, said a Lehman bankruptcy risks an "immediate tsunami" because of the unwinding of derivative and credit swap-related positions worldwide in the dealer, hedge fund and buyside universe.

The trading session "saw very little trading -- perhaps $1 billion total -- but at much wider spread levels for corporate bonds," he said.

Mark Grant, managing director of structured finance at Southwest Securities, based in Dallas, said the lack of transparency in the credit derivatives market is a problem.