Fed warns of persistent processing problems in OTC derivatives market

Fed warns of persistent processing problems in OTC derivatives market

Despite moves by the largest credit derivatives dealers to clear settlement backlogs, the major volume surges in mid-2007 showed that "processing challenges" still persist in the over the counter derivatives (OTC) markets, says The Federal Reserve Bank of New York.

However the Fed has welcomed new commitments by banks to streamline processing of credit and equity derivatives trades outlined in a letter to Fed president Timothy Geithner.

In the letter, dated 27 March, 18 Wall Street banks outline major operational goals for 2008, including consistent use of electronic confirmation platforms for eligible trades and the settlement of trades through a centralised process by September. The dealers also aim to have all novation requests submitted via electronic platforms, rather than e-mail, during the year.

"Our goal is a marketplace that matches its trades on trade date," states the letter.

Regulators originally met with the banks in September 2005 to voice concerns about risk management practices in the rapidly growing credit derivatives market. Following that meeting the banks pledged to automate and streamline operations and cut backlogs. The Fed says since then the dealers have reduced confirmations outstanding more than 30 days by 85%, increased electronic processing to more than 90% of all credit derivative trades and eliminated the risk of novations causing dealers not to know their counterparties.

But soaring volumes in the middle of last year again highlighted persistent processing problems in the OTC credit derivatives markets, says the Fed.

"To support long-term growth, the processing infrastructure must be capable of processing transactions efficiently through periods of sustained high volume and market volatility," says the regulator is a statement.

However the Fed says the bank's new commitments recognise that achieving this objective "requires end-to-end automation, increased interoperability and targeted improvements to the processing workflow".

Read the letter here:

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