Dodd-Frank Clearing Has Risks for Wall Street, Banks Say

Wall Street’s largest banks are exposed to increased financial risks through their membership in clearinghouses charged with guaranteeing most swaps under the Dodd-Frank Act, a trade group said.

Clearinghouses, which accept collateral from buyers and sellers to curb risks in trades, should take steps to limit the liability their member banks face during a default, according to a 29-page report released today by the Clearing House Association LLC. Clearinghouses should also put more of their own capital at risk in a default before losses are passed along to non-defaulting banks, the group said.

“We want to make sure some of the appropriate safeguards are in place at clearinghouses so that a default doesn’t spread contagion throughout the marketplace,” Alex Radetsky, New York- based vice president and assistant general counsel at the group, said today in a telephone interview.

The Commodity Futures Trading Commission and Securities and Exchange Commission are required by the 2010 Dodd-Frank Act to write rules to curb risk in a $639 trillion global market. Lawmakers took action after unregulated trades helped fuel a credit crisis that in 2008 led to the collapse of Lehman Brothers Holdings Inc. and U.S. bailouts for companies including American International Group Inc. (AIG), the New York-based insurer.

The Clearing House Association is a trade group representing the largest commercial banks, including those owned by Bank of America Corp., JPMorgan Chase & Co. (JPM), Deutsche Bank AG and Citigroup Inc. (C) The affiliated Clearing House Payments Company LLC provides payment, clearing and settlement services to member banks. The association doesn’t represent derivatives clearinghouses.

‘Lowers Risk’

“Central clearing lowers the risk of the highly interconnected financial system,” CFTC Chairman Gary Gensler said in a statement last month. The CFTC on Nov. 28 completed rules requiring the first credit-default and interest-rate swaps to be guaranteed at clearinghouses owned by LCH.Clearnet Group Ltd., CME Group Inc. (CME) and Intercontinental Exchange Inc.

Uncertain exposure to losses will undermine confidence in clearinghouse members and create risk for banks that are unmanageable, according to the study. “When a defaulting CCP’s losses are very limited, owners of for-profit CCPs do not have sufficient incentive to ensure that risk is effectively managed,” the study says.

To contact the reporter on this story: Silla Brush in Washington at sbrush@bloomberg.net

To contact the editor responsible for this story: Maura Reynolds at mreynolds34@bloomberg.net

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