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ISDA PRESS REPORT - MARCH 9, 2001
* BoE Clementi Wants More Transparency In Derivatives Mkts - Dow Jones International News * Swaps may move warns BIS - Financial Products * Greenspan Encourages Banks Not to Exercise Too Much Caution - BNA * ISDA seeks derivatives product documentation standard - Risk News * OTC strength hampers new exchange issues - Risk News BoE Clementi Wants More Transparency In Derivatives Mkts Dow Jones International News By Gonzalo Vina LONDON -(Dow Jones)- Bank of England Deputy Governor David Clementi said Friday that booming derivatives markets need to be more transparent to avoid risks to the stability of financial markets. According to prepared remarks for a speech to be delivered at a central banking conference at the Bank of Italy in Rome, Clementi said the documentation recording transactions in derivatives markets also needs to be improved to avert wider shocks in financial markets. "In the banking system, capital and liquidity management are crucial to the management of these risks and have to be adapted to new circumstances," Clementi said. "But the attention of central banks and regulators can't end there. Recent developments in the credit transfer markets and the concerns identified regarding risk management and documentation for credit derivatives illustrate this," he added. Clementi said one of the benefits of the rapid expansion of credit derivative markets, worth around $600 billion a year, is that banks need no longer remain exposed to their large customers. But these same customers can now take on further exposure to other forms of credit through these new instruments without increasing their borrowing. This, he argues, makes it more difficult for creditors, shareholders and regulators to assess risk. Clementi warned that the documentation relating to many of these transactions is often misunderstood or is taken to have different meanings by different parties. He is also worried about how courts in different countries would treat these contracts. Swaps may move warns BIS Financial Products - March 8, 2001 By Andrea Reierson Consolidation in the global banking sector could make it harder to keep swaps the preserve of the OTC marketplace and may push them onto a centralised exchange, the Bank for International Settlements (BIS) said in its quarterly review. "Credit-conscious customers are losing their ability to diversify counterparty credit risk, particularly in their derivatives transactions," the BIS said in its report for the fourth quarter of last year. This increasing concentration of swap books may spark strong pressure for swaps listed on an organised exchange where counterparty risk is taken by the exchange's clearing house, BIS said. Later this month, Liffe is to roll out futures contracts based on euro swaps which will allow traders to hedge two-, five- and ten-year swap contracts in the same way bond traders use futures to hedge positions. BIS also noted the market shift in fixed income benchmarks from government bonds to shorter-term instruments, particularly in the US. This comes amid the trend of declining government debt issuance and debt buybacks while financing grows among parastatal and private sector financing. This would likely see derivatives exchanges introducing contracts based on underlying assets such as corporate bonds and asset-backed securities. In a study accompanying the quarterly review, the BIS found that private instruments eclipsed government paper as a benchmark in the dollar money market over the last two decades. And the bond market's shift away from government securities may have continued even without the declining stock of US government debt issuance. Trading in interest rate swaps has risen relative to futures and options trading in Treasury notes and bonds with transactions in coupon-bearing US Treasuries peaking in 1998 while those in private instruments continue to rise, the BIS said. Global exchange-traded derivatives activity rose 6% in the fourth quarter of last year to $91.5 trillion, buoyed by rising volumes of equity derivatives trade while an increase in money-market transactions offset a decline in government bond related trade, BIS said in its quarterly review. For 2000 as a whole, the value of exchange-traded products rose 10% from the previous year to $383 tr. The value of Interest rate product transactions also grew 10% to $339 tr. Weakening stock markets and increased volatility boosted equity-related trade, prompting increased hedging by investors, BIS said. Expectations of easier monetary policy in the US led to buoyant activity in short term interest rate products with the dollar value of US money market contracts up 20%. The continued expansion of the interest rate swaps market also underpinned demand for money market products, typically the most common hedging vehicle for swaps and swaptions. By the end of June last year, the total notional amount outstanding of all OTC derivatives stood at $94tr up 15% from the same period in 1999. The notional outstanding amount of OTC single-currency interest rate derivatives was $64tr, while OTC equity-linked derivatives posted a gain of 13% to $1.7 tr. Greenspan Encourages Banks Not to Exercise Too Much Caution BNA - March 9, 2001 Even as he acknowledged that lax credit standards can jeopardize banks' solvency and have contributed to deteriorating bank earnings, Federal Reserve Chairman Alan Greenspan March 7 cautioned bankers not to be overly careful about making loans. ''Lenders and their supervisors should be mindful that in their zeal to make up for past excesses they do not overcompensate and inhibit or cut off the flow of credit to borrowers with credible prospects,'' Greenspan told a convention of the Independent Community Bankers of America in Las Vegas. Greenspan said community bank lending has had little to do with recent contractions in loan quality. "Today's problems generally relate to syndicated credits, especially those to leveraged borrowers," he said. "As problems materialized, earnings fell significantly for some of the larger banks, which in turn caused aggregate commercial bank industry earnings to fall slightly during 2000, thus bringing to an end the industry's string of ten consecutive years of higher earnings. "Nevertheless, though the effects of these excesses are likely to continue for much of this year in the form of moderately deteriorating asset quality and earnings at some of the larger banks, these problems, one hopes, will prove modest both by historical standards and relative to the resources of these institutions." Greenspan said bank regulators are paying close attention to smaller commercial banks' increased real estate lending. "Though underwriting practices appear to be much healthier today than they were in the 1980s and standards have tightened somewhat recently, supervisors are paying particular attention to community banks with concentrations that make them materially vulnerable to a downturn in this market," he said. Nevertheless, Greenspan was also somewhat critical of banks' lending judgment. ''It is interesting to note that the length of the current expansion, coupled with the absence of problem commercial loans until recently, has led to some depreciation in both bankers' and supervisors' skill in handling weakened or troubled credits,'' he said, referring to the problem lending of the late 1980s and early 1990s. To community bankers concerned that it has become increasingly difficult to attract the deposits necessary to maintain a healthy lending portfolio, Greenspan offered the other side of the coin: "It is also important to recognize that the reduction in portfolio liquidity is more a product of good business--high loan demand--than of the relatively slow growth in core deposits." Greenspan's comments further confirm earlier indications that he does not support proposals to raise deposit insurance coverage provided by the Federal Deposit Insurance Corporation above the current $100,000 per account provided now. Recently, FDIC adopted the position that deposit insurance coverage levels should be raised. Several bills pending in Congress would raise coverage levels to $200,000 per account. Banks O.K. With Basel Lastly, Greenspan said most banks have submitted comments to the Fed in support of the new Basel Accord, which recommends new capital standards for banks. Responses to a request for comment related to the new Basel Accord and an alternative proposal by the Fed that could simplify capital standards for U.S. banks show that most banks prefer the Basel Accord, he said. "The responses to date indicate that community banks in general do not believe that the current accord is burdensome, mainly because the costs of adapting systems and reporting for such an approach have already been incurred," Greenspan said. "Indeed, some commentators indicated that a change to an even simpler system would in itself be more burdensome than sticking with the current regime." The Fed, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and FDIC issued an advance notice of proposed rulemaking on the matter in October. Comment letters have indicated cautious support for simpler methods of calculating capital adequacy, but not if "simplicity" means meeting tougher capital criteria. Many banks have also reported to the Fed that they are not in favor of a stand-alone leverage ratio with much less complexity and reporting if it means that bank supervisors would set the a minimum ratio higher than is required by the current leverage standard, Greenspan said. "Many of the responses indicated that was not a favorable trade-off, even though most community banks have exceptionally strong leverage ratios," he said. "I should emphasize that we are still analyzing your many excellent comments to determine what kind of response we should give." ISDA seeks derivatives product documentation standard Risk News - March 8, 2001 By John Ferry Members attending the International Swaps and Derivatives Association (ISDA) conference in Houston this week reached general agreement that there is a need to standardise derivatives 'master agreements' - legally binding counterparty contracts. "There was much discussion about reconciling the variety of product documents for risk management purposes," said Ruth Ainslie, senior policy director at ISDA, the global trade association that represents over-the-counter (OTC) derivatives market participants. The possibility of creating a single 'master master' agreement that covers both physical and financial products was actively discussed, with advocates citing such contracts would improve efficiency by simplifying the negotiation process for market operators. Doubts were expressed by some participants, however, regarding the feasibility of developing a 'master master' contract, especially concerning administration, legal and negotiation difficulties with cross-affiliate master agreements. OTC strength hampers new exchange issues Risk News - March 6, 2001 By Christopher Jeffery The continuing dominance of the over-the-counter (OTC) derivatives marketplace has meant the plethora of new exchange-traded products introduced in the past few years have had only limited success. While a number of contracts like 10-year Treasury notes have seen significant trading volumes, evidence collated by the Bank for International Settlements (BIS) suggests that growth has been at the expense of other exchange-traded contracts, and not due to an erosion of OTC activity. "Few of the contracts introduced by established marketplaces in recent years have met with an enthusiastic response, and the gains enjoyed by some contracts have largely reflected a reallocation of business away from traditional benchmarks," said BIS economist Serge Jeanneau in the international body's Quarterly Review. Jeanneau added that this trend was most acute in the US, where net repayments of government debt combined with a shift of issuance to intermediate maturities have affected the liquidity of the Treasury bond contract and led to a near displacement by the 10-year Treasury note. Europe, however, has also witnessed displacement activity. "A reallocation of activity also took place in Europe in the late 1990s, with Eurex capturing business in the long-term segment of the euro yield curve and Liffe achieving dominance in the short-term area," said Janneau in the report. Janneau believes the falling number of non-government issues in the near future will lead to exchanges introducing contracts based on corporate and asset-backed securities. Examples of likely future behaviour include the US Bond Market Association's move last September to develop proposals for a corporate bond futures contract, and CBOT's efforts to introduce mortgage-backed contracts. Janneau added that he also expects exchanges to look at introducing instruments based on broader fixed-income indexes and not just government or corporate securities in the next few years. Many investment banks already offer such services. **End of ISDA Press Report for March 9, 2001.** THE ISDA PRESS REPORT IS PREPARED FOR THE LIMITED USE OF ISDA STAFF, ISDA'S BOARD OF DIRECTORS AND SPECIFIED CONSULTANTS TO ISDA. THIS PRESS REPORT IS NOT FOR DISTRIBUTION (EITHER WITHIN OR WITHOUT AN ORGANIZATION), AND ISDA IS NOT RESPONSIBLE FOR ANY USE TO WHICH THESE MATERIALS MAY BE PUT. Scott Marra Administrator for Policy & Media Relations ISDA 600 Fifth Avenue Rockefeller Center - 27th floor New York, NY 10020 Phone: (212) 332-2578 Fax: (212) 332-1212 Email: smarra@isda.org
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