Limit Use of Derivative Harbors to Cut Systemic Risk, CFS Says
Derivative trades that aren’t cleared by a third party should be denied protection offered by bankruptcy laws as a way of stemming systemic risk, according to Bruce Tuckman of the Center for Financial Stability.
Under U.S. law, when an entity on one side of a derivative trade goes bankrupt, counterparties can close their contracts and immediately seize what’s owed from the debtor’s assets, avoiding court proceedings. That benefit should be limited to trades where a third party manages collateral and sets prices, said New York-based Tuckman, director of financial markets research at the CFS and a former executive of Barclays Capital.
U.S. regulators are seeking to implement the provisions of the Dodd-Frank Act regarding the $583 trillion swaps market, in an attempt to reduce risk to the financial system by forcing trades to go through clearinghouses. The Commodity Futures Trading Commission, the derivatives regulator, has issued nine rules about clearing without any of them setting out what has to be cleared, according to Tuckman.
If “safe harbors” were withdrawn from derivatives that weren’t cleared by an outsider, traders would be discouraged from using the contracts, Tuckman said. At the same time, traders would clear the more liquid derivatives on their own initiative, meaning safe harbors would only apply where the contracts reduce systemic risk, he said.
Bilateral trades would enjoy protection in a bankruptcy provided they were cleared by an outsider.
To contact the reporter on this story: John Glover in London at johnglover@bloomberg.net
To contact the editor responsible for this story: Paul Armstrong at Parmstrong10@bloomberg.net
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