Report Sees Backlog Peril

McLEAN, Va. (HedgeWorld.com)--BearingPoint Inc., a technology consultant, issued a white paper on what it sees as a backlog crisis in the credit derivatives industry.

In a press release issued with the paper, BearingPoint observed that on Thursday [Feb. 16], the New York Federal Reserve is expected to meet to discuss dealers' and industry executives' progress on the resolution of this backlog.

"In fact, the overstressed credit derivatives market infrastructure has created the potential for a financial disaster if an event triggers a significant strain, such as a major U.S. company filing for bankruptcy," said Robert Benedetto, a manager at BearingPoint and one of the coauthors of the study. "Unless this technology is updated and improved, the industry will continue to operate with lead weights and put the health of the market overall at risk," he added.

The paper states that recent progress in the standardization of the terms of credit derivatives contracts has been, from the point of view of the orderly processing of transactions, a mixed blessing, because it has stimulated additional interest from market participants, especially on the buy side, which has increased the volume.

Hedge funds frequently assign their contract positions to third parties as a quick way of exiting a position and securing a profit. The paperwork for such assignments is especially onerous, though, which again increases the operational risk prevalent in the industry.

"A paramount concern is that, in a worse-case scenario, a potential string of corporate defaults could pose a significant systemic risk to financial markets, creating cascading flow-through effects on both interest rates and the economy as a whole," the paper said.

It also outlined steps that parties could take to reduce backlog, such as a new process for confirming trades.

CFaille@HedgeWorld.com

Contact Bob Keane with questions or comments at bkeane@investmentadvisor.com.

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