Clearing and central counterparty systems should be developed to cover the standardized contracts which account for the majority of CDS trading, according to the Turner Review of global banking regulation.
Lord Turner, chairman of the UK FSA, was asked by the Chancellor of the Exchequer to review the events that led to the financial crisis and to recommend reforms.
According to the report: “The FSA strongly supports the objective of achieving robust and resilient central clearing house arrangements for CDS clearing and has been working with other regulatory authorities (in particular those in the US and Europe) and potential market infrastructure providers to expedite this progress.
“We also welcome European Commission initiatives to ensure that appropriate structures are in place, while believing that proposals that euro-denominated CDS must be cleared ‘within the Euro zone’ are unnecessary for financial stability reasons which requires only that robust and well regulated arrangements are in place regardless of location.”
The report also questions the effectiveness of CDS: “Bank CDS prices before the crash of 2007 did not provide forewarning of the scale of problems ahead. They were moderately successful in indicating the relative riskiness of different institutions – e.g. suggesting that Northern Rock was more risky than other banks.”
Regarding direct regulation on CDS products: “Regulators should not treat it is as given that direct product regulation is by definition inappropriate, but should be willing to consider over time whether particular markets have characteristics sufficiently harmful, and benefits sufficiently slight, as to justify intervention.”