Clearing houses could transform CDS risk management

INTERLAKEN, Switzerland (Reuters) - Clearing houses acting as central counterparties could transform risk management in the credit derivatives market, a NYSE Euronext NYX.PANYX.N executive said on Thursday.

Banks and other financial firms around the world have taken over $408 billion on credit-related writedowns and losses since the credit crunch hit in the third quarter of 2007.

Financial institutions could have become aware of the extent of their losses earlier if they had had used a clearing house as a counterparty when trading in the credit default swap (CDS) market, NYSE Euronext Executive Director Garry Jones told Reuters on the sidelines of the Swiss Futures and Options Association’s annual meeting.

“They would have been aware of the changing market value of their positions and it might have meant that banks could have reconsidered their risk profile,” he said.

“By using a clearing house, banks would have had to mark to market their positions and pay variation margins every day,” he said.

“You can still do lots of trades with several counterparties, but if the market is centrally cleared through a clearing house, then your longs and shorts can be netted for better capital efficiency,” he said.

NYSE Euronext’s Liffe unit has said it will begin offering trading through its BClear OTC facility in credit default swaps based on the benchmark European credit derivative indexes in the fourth quarter.

Credit default swaps are used to bet on the credit quality of a company or sovereign issuer or protect against the likelihood of default.

“Major losses in financial markets have made people focus on correct mark to market positions and on counterparty risk and that will help to focus on a central clearing counterparty as opposed to keeping track of all other counterparties,” he said.