Trichet at ISDA 2007 - Boston
Wednesday, April 18th, 2007
Trichet warns on ‘complacent’ markets
By Richard Beales in Boston
Published: April 18 2007 19:56 | Last updated: April 18 2007 19:56
Jean-Claude Trichet, president of the European Central Bank, on Wednesday called for concerted market action to improve transparency in global credit derivatives markets, where he said “opacity” made it difficult to assess risks to the financial system.
The private, over-the-counter nature of derivatives markets makes them notoriously difficult to measure and monitor, but the explosive growth in the use of credit derivatives continues as increasing numbers of traditional asset managers and pension funds join investment banks and hedge funds in the market.
“The opacity of the credit derivatives market, and especially of structured synthetic instruments, is a potential source of concern,” Mr Trichet said.
He added that the ECB would encourage industry initiatives to promote transparency. “The reduction of systemic risk is not an objective for central banks exclusively.”
Mr Trichet’s remarks came as the leading industry body released data showing that the outstanding notional volume of credit derivatives contracts more than doubled to $34,500bn in 2006.
The International Swaps and Derivatives Association, at whose annual meeting Mr Trichet was speaking, also said interest rate derivatives saw higher than usual growth last year with the market expanding by 34 per cent to $285,700bn outstanding notional.
Mr Trichet said while credit derivatives allowed market participants to improve risk management and distribute exposures more widely than in the past, this enhanced the resilience of the financial system only if certain conditions were met.
These included accurate measurement and pricing of risks, strong risk management and an appropriate mix of investor views, behaviour and risk appetite, as opposed to a mass of money taking the same positions.
Supporters of the role of credit derivatives often point to the large-scale collapses of companies such as Enron, WorldCom and Parmalat, and the fact that no banks were brought down as a result, as proof of the markets functioning correctly.
However, Mr Trichet said the conditions he spoke of were not always met and that credit derivative instruments had not yet been seriously stress-tested.
“Aggressive investors display a more volatile risk-taking attitude, and their balance sheets are not necessarily resilient enough to withstand major shocks or increases in volatility,” he said.
Ken Lewis, chief executive of Bank of America, also speaking at the conference, emphasised the importance of derivatives to risk management. He conceded, however, that the financial industry’s response to potential problems with derivatives had “not always been reassuring”.
The industry had allowed, for example, the build-up of problems with executing and documenting credit derivatives trades, which resulted in extreme regulatory pressure to clean the industry up last year. But banks and the rest of the industry needed to understand and act pre-emptively, for the good of both clients and the market, to avoid a backlash of over-regulation.
“Derivatives do not eliminate risk – they simply redistribute it. The underlying risks still exist,” he said.
“Understanding where those risks are and who is holding them is primarily the responsibility of those who have taken them on. But to some degree it is also our [collective] responsibility.”
Separately, a European Central Bank report said private equity poses only a remote risk to financial stability and Europe’s banking industry.
The pioneering survey of 41 large banks found scant evidence that corporate leveraged-buyouts (LBOs) by private equity groups could create serious difficulties for the financial system.
Additional reporting by Paul J. Davies in London
Copyright The Financial Times Limited 2007
http://www.ft.com/cms/s/1a1b6912-edcf-11db-8584-000b5df10621.html