Fed calls for action on equity derivatives

Fed calls for action on equity derivatives

Federal regulators are calling on the investment industry to tighten up procedures for trading in over-the-counter equity derivatives, after lauding progress in risk containment in the credit derivatives market.

A year ago 14 of the major credit derivatives banks pledged to clear settlement backlogs and tighten back office risk management procedures in the credit derivatives markets.

In a statement released following its third meeting with the banks, the Fed says credit derivative dealers have doubled the volume of trades processed electronically to 80% and reduced the number of outstanding confirmations by 70% and confirmations outstanding for more than 30 days by 85%.

Banks have also ended the market practice of assigning trades without obtaining prior consent of the counterparties, and have agreed upon an electronic messaging protocol for the settlement of a credit event.

Going forward, the Fed says it is important to see the participants' "robust adoption" of the newly created trade information warehouse, developed by the dealer community in collaboration with the Depository Trust and Clearing Corporation.

At the meeting the Fed also discussed for the first time problems in processing of equity derivative trades.

"We look forward to seeing the industry improve the automation and standardisation of over-the-counter equity derivatives trading and reduce the current levels of unconfirmed trades," the Fed says in the statement.

The Fed asked the 16 equity derivatives dealers at the meeting to set targets to help reduce equity derivatives backlogs, but it is not expected to impose a timetable for reductions itself.

In a separate statement, the International Swaps and Derivatives Association (Isda) says the industry made equity derivatives confirmations an area of "immediate priority" and its members will be assisted in this task by the increasing availability of automated systems, supported by Financial products Mark-up Language (FpML).

Isda also says it has developed a protocol that will enable cash settlement of credit derivatives. The new protocol permits cash settlement of single-name, index, tranche and certain other plain vanilla credit derivative transactions.

Robert Pickel, Isda CEO, says: "Isda's new cash settlement protocol is another major step in streamlining market and operational processes for privately negotiated derivatives."

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