A report commissioned by the City of London Corporation has stated that Londons status as the top global financial center is under threat if regulators are unable to distinguish between OTC derivatives that contributed to the credit crunch, and those that did not.
An article in the Financial Times (Monday, 27th April) states that the report, prepared by consultancy Bourse Consult, urges regulators not to throw the baby out with the bath water, as regulators decided whether to act on recent calls for greater regulation on the OTC markets.
According to the report, London accounts for 43% of the value of all OTC trades. The report notes: The credit derivatives which were traded most heavily on the OTC derivatives markets were CDS. There is very little evidence to suggest that these contributed in any significant way to the crisis.
Robin Johnson, corporate partner at international law firm Eversheds, comments:
Derivatives are an essential part of a fully functioning market. Their role of spreading risk allows providers of first level finance to continue to provide essential resources.
There are a number of issues that are affecting the derivatives market at the moment. For example, with interest rates being driven down earlier this year margins have become wafer thin, resulting in even a small default leading to a tsunami. Furthermore accounting rules of fair value lead to valuations of derivatives being capable of being artificially inflated in a thinly traded market and insurance companies became the ultimate risk bearer fuelling more and more trading. This has also been driven by the lack of disclosure in interlocking positions.
Rather than regulation of the products themselves the focus should be disclosure and governance of risk management policies of financial institutions engaged in derivative trading.