Thursday, February 4, 2010

Who regulates credit default swaps?

Original posted on How Insurance Works:

The over-the-counter market, where credit default swaps are traded, is not directly
overseen by federal financial regulators. On the other hand, the use of credit default swaps
by the institutions with the largest market share, banks, is regulated. More specifically,
the risk management practices of banks are subject to direct supervision by the federal
regulators who coordinate through the Federal Financial Institutions Examinations
Council (FFIEC).5 Use of credit default swaps and other complex derivatives is
concentrated in the largest commercial banks, most of which are federally chartered
institutions regulated by the Office of the Comptroller of the Currency (OCC), which is
a member of FFIEC. Because the efficiency of the over-the-counter derivatives market
affects the safety and soundness of federally chartered banks, the OCC “... spends a
considerable amount of time and resources evaluating the risk control systems these banks
use to manage risk in derivatives markets.”6

The OCC is not the only institution with an interest in monitoring and proposing
changes to credit default swaps and related markets. The Securities and Exchange
Commission (SEC), for example, has conducted notice and comment rulemaking for
credit default swap options on the Chicago Board Options Exchange.7 Also, the Federal
Reserve Bank of New York has been working with the ISDA to facilitate the tracking of
counterparty obligations.8 In addition, private market participants have issued reports and
made recommendations for the standardization and resolution of counterparty risk.9

Endnotes

5 CRS Report RL33235, Banking and Securities Regulation and Agency Enforcement Authorities,
by Mark Jickling, Gary Shorter, M. Maureen Murphy, and Michael V. Seitzinger.

6 Testimony of Kathryn Dick, Deputy Comptroller for Credit and Market Risk, Before the
Subcommittee on Securities, Insurance, and Market Risk of the Senate Committee on Banking,
Housing, and Urban Affairs, July 9, 2008.

7 Securities Exchange Act Release No. 34-55871 (June 6, 2007).

8 “Statement Regarding June 9 Meeting on Over-the-Counter Derivatives,” Press Release, Federal
Reserve Bank of New York, June 9, 2008.

9 One example is a study group formed by major investment banks and market makers, including
Goldman Sachs & Co. and Citigroup, which issued The Report of the Counterparty Risk
Management Policy Group II, July 27, 2005, available here.

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