CHICAGO (HedgeWorld.com)–Credit derivatives dealers enjoyed a victory Wednesday as 14 major credit derivatives market participants reported that the backlog of outstanding trade confirmations has been reduced by more than 80% on average since Sept. 30, 2005, besting the group’s own previously set target of a 70% reduction.

The 14 dealers, which include some of the largest investment banks, were assembled by the Federal Reserve Bank of New York last fall and, along with representatives from The Bond Market Association and the Managed Funds Association, began meeting to discuss issues arising from credit derivatives trading practices. One of the major goals was to reduce the number of confirmations outstanding for more than 30 days by June 30.

Investment in credit derivatives has exploded in the last two years, due in part to alpha-searching hedge funds turning to more esoteric strategies for returns; hedge funds are estimated to drive approximately 25% of credit derivatives trading volume. According to the International Swaps and Derivatives Association, credit default swap trading volume grew 105% in 2005 and 123% in 2004.

The growth of the market, along with the development of new products, are two major factors behind the backlog of unconfirmed credit derivatives trades, according to Karel Engelen, policy director at the ISDA. “A lot of times people develop these new products, but it takes a while to get a foundation for processing and operation areas,” he said.

Another issue is outstanding novations, which the ISDA has addressed via the 2005 Novation Protocol, a uniform process for parties using ISDA master agreements to obtain consent for transfers of interest in credit derivative transactions.

To clean up the existing backlog, estimated by the Federal Reserve Bank of New York to have totaled 150,000 unconfirmed trades, the dealers held bilateral “lock-in” meetings that involved going through outstanding confirmations and trying to solve them, Mr. Engelen said. Meanwhile dealers have been urging market participants toward electronic processing for credit derivatives trades, and traders are beginning to get on board.

That effort will continue, Mr. Engelen said: “One of the main ways to get there is to push forward on making the number of electronic trades as high as possible, which means a need to cover new products on platforms that exist, and make sure all players in the market connect to one of those platforms.”

The group’s efforts have already had a noticeable effect. In the ISDA’s 2005 Operations Benchmarking Survey, there was a clear reduction in the number of outstanding confirmations in the last quarter of 2005, Mr. Engelen said.

In addition to reducing the number of outstanding trade confirmations, the dealer group also set forth “Standard Industry Processing Guidelines” to be implemented industry-wide by Oct. 31, 2006. Those guidelines include:

  • All confirmable trade events that can be processed electronically through an industry-accepted platform should be processed as such;
  • Details of trades eligible for electronic submission should be submitted to an electronic platform within one business day and matched/affirmed within five days; and
  • Confirmation for trades not eligible for electronic submission should be issued within 10 days, and the recipient should respond within 10 days of reception. The trade should be confirmed within a maximum of 30 days.

Also in development is a central data warehouse for credit derivatives trades, which the dealers group is working on in conjunction with the Depository Trust and Clearing Corp. The data warehouse would keep and hold a copy of each confirmed trade.

The banks comprising the dealers group are: Barclays Capital, Bear Stearns, Citigroup, Bank of America Corp., Deutsche Bank, Credit Suisse First Boston, Goldman Sachs, JP Morgan Chase & Co., HSBC, UBS, Morgan Stanley, Merrill Lynch, Lehman Brothers and Wachovia Corp.

JBunge@HedgeWorld.com

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