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.