Dealers and investors in the $45,000bn credit derivatives market on Thursday took steps to address heightened regulatory concerns about the industry’s ability to cope with soaring trade volumes.
In a letter to the New York Federal Reserve, dealers including Goldman Sachs and Credit Suisse committed to a series of measures to improve the speed and efficiency of trade processing, primarily through the greater use of electronic platforms and solutions.
The rapid growth of the over-the-counter derivatives market in recent years has created backlogs of unconfirmed trades for middle and back offices that have been unable to keep pace with soaring trade volumes and the increasing complexity of the trading instruments.
“Heightened price volatility and surging trading volumes underscore the need for the OTC derivatives market infrastructure to evolve to support this expansion,” US Treasury secretary Hank Paulson said in a speech this month.
In spite of efforts to move credit derivatives trades to electronic processing, many trades are still confirmed via email or fax, which makes errors more likely, harder to detect and more difficult to fix.
The letter comes in response to pressure from the New York Fed and more recently, the US Treasury, to improve the infrastructure supporting the market and reduce the potential systemic risk arising from backlogs of unconfirmed trades.
The market volume and the complexity of the instruments being traded required a “clear, functional, well-designed infrastructure,” Mr Paulson added.
The New York Fed first highlighted the problems in the market in September 2005, prompting dealers to begin efforts to address the problems. But recent market volatility and heightened trading volumes have once more exposed the market’s shortcomings.
“The volumes have led to an overwhelming amount of trade entry [for people using manual processes],” said Nicholas Stephan, chief executive officer at interdealer broker Phoenix Partners Group in New York.
“People are coming around to the need for automation and electronic execution and processing. It makes [the market] more efficient, it reduces operational risk and it’s generally cleaner,” he said.