Major credit derivatives market makers,
J.P. Morgan Chase, have
unanimously agreed that a regulation in the proposed Basel Capital
Adequacy Accord would treat credit derivatives unfavorably compared
to bank guarantees and should not be adopted. Over 40 derivatives
professionals and three trade organizations met in London last week
to thrash out a response to the proposals.
The proposal is "absolutely unjustified and
should be abolished," according to
Emmanuelle Sebton, head
of risk management at the
Swaps and Derivatives Association
Watzinger, managing director of debt
markets and credit derivatives at
in London, agreed. If credit
derivatives work then banks should not need to put excess capital
behind them and if they do not the product is useless and that
would be reflected in the pricing, he argued.
The sticking point, according to bankers, is the
so-called W-factor: a proposed increase in the amount of regulatory
capital banks would have to assign to credit derivatives positions.
Under the current Basel Accord credit derivatives purchased from
anOrganisation for Economic Co-Operation
bank reduces the amount
of regulatory capital the bank has to put behind the trade to 20%.
The proposal stipulates that credit derivatives can only reduce the
amount of regulatory capital required on 85% of its exposure: the
remaining 15% will have a 100% risk weighting. Conversely, a bank
guarantee will reduce the amount of regulatory capital to 20% for
all the portfolio.
credit risk manager at the
in London and a member
of the credit risk mitigation group for the Basel Committee, said
it is not going to change the regulation because market makers do
not like it, they will have to prove it wrong. Bank guarantees have
been around for a long time and have proved they work, but credit
derivatives are a new product, he said, adding that documentation
associated with the product is in a state of flux.