Regulators urge international action on derivatives


Central banks and financial houses will work together to fix troublesome markets

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Regulators Urge Joint Action on Derivatives

By Gillian Tett and Anuj Gangahar
Financial Times, London
Wednesday, September 27, 2006

Three of the world's most powerful financial regulators have taken the unusual step of issuing a joint warning that individual nations cannot contain some of the risks posed by the explosive growth of derivatives and must collaborate across borders.

The dramatic pace of integration and innovation in global markets makes it increasingly difficult to solve problems with "a local or national solution," top officials from the UK Financial Services Authority, the Federal Reserve Bank of New York, and the U.S. Securities and Exchange Commission write in the Financial Times.

"In a more integrated global market, we will increasingly find ourselves compelled to pursue borderless solutions," write Timothy Geithner, president of the New York Fed; Sir Callum McCarthy, chairman of the FSA; and Annette Nazareth, a commissioner at the SEC.

The comments come after leading global investment banks, institutional investors, and international regulators met at the New York Fed on Wednesday to discuss industry initiatives to improve back-office systems for derivatives trading. The move follows concern last year that back-office backlogs were so serious they could create systemic problems if not addressed.

At the New York meeting, regulators said a process of co-operation between the United States and European regulators last year had cut credit derivatives backlogs, but warned that the industry still needed to tackle serious backlogs in the equity derivatives world. Their comments prompted the International Swaps and Derivatives Association to declare that it would take urgent action.

In the FT article, the regulators suggest the U.S.-European initiative could act as a model for co-operation on broader issues in the future. "In the case of derivatives, a local or national solution would have been insufficient to protect domestic financial markets from the risks posed by market practices," they said.

"To fix the credit derivatives problem, it was necessary to involve a large and diverse pool of financial institutions. No firm or national authority had the capacity to make progress on its own."

The comments will be closely watched in the financial industry. Although U.S. and European regulators have co-operated extensively behind the scenes in recent years, this collaboration has been discreet, since national supervisors have been expected to handle problems in their local markets. As a result, when Long-Term Capital Management, the U.S. hedge fund, imploded in 1998, the New York Fed facilitated rescue efforts by local, Wall Street investment banks.

However, the growing integration of capital markets is making it easier to transmit shocks across borders. When Amaranth, the U.S. hedge fund, lost $6 billion this month in U.S. gas markets, this triggered a massive fire sale of Amaranth's loans in London.

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