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The Actuary The magazine of the Institute & Faculty of Actuaries
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US considers curbing the credit derivatives market

Senior Democratic lawmaker Collin Peterson has released draft legislation that could outlaw most types of credit derivatives trading, dealing a hammer blow to the $30 000bn credit derivatives market. The draft would ban the trading of credit default swaps (CDSs) unless investors owned the underlying bonds or loans on which the credit insurance was bought.

CDSs offer insurance against counterparty defaults. Until recently the contracts were not classified as insurance business in the US and, therefore, not subject to the capital requirements usually meted out to insurers. Very few CDS trades are carried out to cover an actual bond position, with many trades placed to bet on future creditworthiness or to hedge more general positions.

The proposals also call for all over-the-counter derivatives trades, not just credit derivatives, to be cleared via clearing houses. Although the draft in its current form may never be adopted, it offers an insight into legislators’ attitudes to developing a new supervisory framework for less transparent sectors of the capital markets. Previous faith in self-regulation of financial markets is now considered to be misplaced.

In a recent statement, Eraj Shirvani, chairman of the International Swaps and Derivatives Association (ISDA) and head of credit sales and trading at Credit Suisse, said: “Throughout the crisis, credit default swaps have remained available and liquid. They have been the only means of hedging credit exposures or expressing a view at a critical time for the industry. Impairing their use would be counterproductive to efforts to return the credit markets to a healthy, functioning state.”