Participants in the UK Over the Counter credit derivatives market may be exposing themselves to greater market risk than they realize, accor...

Participants in the UK Over the Counter credit derivatives market may be exposing themselves to greater market risk than they realize, according to the Financial Services Authority, the UK’s lead regulator. The FSA has recently become concerned at the high level of unsigned confirmations outstanding between counterparties in this market. In some cases, transactions have remained unconfirmed for months. The regulator is taking this very seriously and has written to the chief executives of major participants that it is their responsibility to ensure that their firm has back office systems and controls capable of keeping pace with the growth in their OTC credit derivatives business. An FSA spokesman told WealthBriefing that the problem lies not with the possibility of default – counterparties can always refer to tapes to prove a deal – but rather a firm may not be aware of a trade and as a consequence have more market risk than they thought. Although no absolute figures for transgressions could be divulged, the FSA contend that the problem is large enough to cause concern and although it concedes that some work has been done by firms to rectify inadequacies, this is still very much a live issue. This problem, which applies just as much to larger as smaller firms, has come to light in the normal course of the FSA’s supervisory role rather as a result of a substantive failure. Gay Huey Evans, FSA's Capital Markets Sector Leader, said: "The FSA believes that credit derivatives continue to be an important tool for diversifying risk and as a method for bringing increased liquidity to all segments of the credit market. "However with benefits come risks and if simple operational procedures are unable to keep up with the pace of market development, the risk that misunderstandings and uncertainty will negatively impact market confidence increases. We will continue to monitor firms' progress on this issue".