Investment banks said to be developing credit derivatives clearing house

Filed under: International markets, Other issues, Housing

Deutsche Bank and other investment banks are apparently working on plans to develop a clearing house for the credit derivatives markets, in an effort to allay rising regulatory concern and investor skittishness about counterparty risk, The Financial Times reported Friday.

Deutsche Bank (NYSE: DB) and other banks are apparently trying to develop a plan that would allow only institutions with strong capital bases and credible trading histories to clear trades in the credit default swap markets with a central counterparty, The FT reported.

The derivatives market has experienced explosive growth in the past decade, with the instruments’ value totaling $350-$450 trillion, depending on the methodology used. At the same time, the credit default swaps market has grown to $45-50 trillion.

Global clearing house

Economist David H. Wang told BloggingStocks Friday that, ideally, a global derivatives clearing house should take the form of a public, international organization administered by member nation states. Failing that, he’d like to see a private international organization administered by the major investment banks.

The new overseeing organization would maintain counterparty solvency, liquidity, and integrity — something that’s intrinsic to properly functioning markets, in general, as well as the derivatives market.

“Unlike what some critics hope for, the derivatives market is not going to go away. You can not turn back the clock. Derivatives are part of and play a role in the international financial system,” Wang said. “The challenge now is to create a clearing house or exchange with standards and rules, so that all parties know the composition, value, price, and risk of all instruments at all times. An organization of that scope will not be easy to form, but the financial system will be better off if one is put in place.”

The role and impact of derivatives came into question in August 2007 after two derivative-laden Bear Stearns (NYSE: BSC) hedge funds failed as the housing boom ended, resulting in a series of related asset-backed-securities mark-downs that temporarily froze the credit markets, and precipitated the current credit crunch.

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