Patrick Parkinson

U.S. banks' direct exposures to losses from downgrades of guarantors' ratings appear to be moderate relative to the banks' capital...

Of greater concern is the potential for losses at banks that have hedged their holdings of super senior tranches of CDOs of ABS with credit protection purchased from the guarantors.  These hedges lose value when the financial condition of the guarantors deteriorates.  In fact, many banks already have written down the value of their hedges significantly to reflect the market view that some guarantors may not meet their obligations on the protection they sold to the banks. 

A CCP has the potential to reduce counterparty risks to OTC derivatives market participants and risks to the financial system by achieving multilateral netting of trades and by imposing more-robust risk controls on market participants.  However, a CCP concentrates risks and responsibility for risk management in the CCP.  Consequently, the effectiveness of a CCP's risk controls and the adequacy of its financial resources are critical.  If its controls are weak or it lacks adequate financial resources, introduction of its services to the credit derivatives market could actually increase systemic risk.

A CCP that seeks to offer its services in the United States would need to obtain regulatory approval.  The Commodity Futures Modernization Act of 2000 included provisions that permit CCP clearing of OTC derivatives and require that a CCP be supervised by an appropriate authority, such as a federal banking agency, the Commodity Futures Trading Commission, the SEC, or a foreign financial regulator that one of the U.S. authorities has determined to satisfy appropriate standards.  A CCP for credit derivatives with standardized terms that was not regulated by the SEC might need an exemption from securities clearing agency registration requirements.