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Credit Default Swaps to be traded through a central clearing house

Financial regulatory system to be overhauled by Obama’s team

It is gratifying to note that the Obama administration is planning to quickly tighten the nation’s financial regulatory system. Wide-ranging changes, including stricter federal rules for hedge funds, credit rating agencies and mortgage brokers is expected soon. There is also bound to be a greater oversight of the complex financial instruments that fueled the economic crisis. Some of these actions require statutes, while others are achievable through regulations adopted by several federal agencies.

Credit Default Swaps, the insurance contracts against credit risks and which were primarily responsible for the financial crisis in 2008 is slated to be traded through a central clearing house and possibly through stock exchanges. Financial experts believe that some credit default swaps with unique characteristics negotiated between companies might not be able to trade on exchanges or through clearinghouses. But standardized or uniform ones could. The Obama team wants to make sure that the standardized part of those markets move into a central clearinghouse and onto exchanges as quickly as possible, as that is really important for the system. It will help reduce risk and the system as a whole.

The New York Times reports “The new trading procedures for derivatives could also enable regulators to impose capital and collateral requirements on companies that issue credit default swaps that would make them safer investments. American International Group, one of the largest issuer of such swaps, never had to post collateral and nearly collapsed as a result of issuing a huge volume of such instruments that it was unable to support.”

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