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Published by Sunday Business, The European Newspaper Group, 18 March 1998
Credit Derivatives Folly
This article forms the basis for a chapter in "Key Financial Instruments: understanding and innovating in the world of derivatives" Jan. 2000, Commissioned by Financial Times Prentice Hall ISBN 0273 63300 7 London link
SIR - The fast growing Credit Derivatives market ($20 bn in 1996 to an expected $100bn before 2000) is eerily familiar.
Traders are offering pure "insurance" against a default. But many countries strictly separate banking from insurance business. And credit derivatives are but a small step from credit insurance.
The UK financial law panel paper on the point more or less suggested that all of the regulators should get together and decide how to regulate the business. Nobody would then take issue if all of the regulators were agreed.
Most people have no idea of how this scenario will play out in other legal jurisdictions. It appears that bankers are taking the same approach to doing business that they did with local authority swaps a decade ago. The markets do not appear to have learnt any lessons notwithstanding the long list of derivative disasters. There may very well be an insurance company which decides to protect its own patch; or an overseas regulator of a bank or a securities house which challenges an institution's transactions; or perhaps an insolvency practitioner will take the point; or a firm that has simply lost money on a credit derivative.
Whilst not seeking to generate another bout of Derivatiphobia, it appears that in order to ensure that transactions are generated the market has developed collective amnesia and is prepared to build a huge global position based on shifting sands.
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