FSA issues warning to credit derivatives traders

The Financial Services Authority told brokers and traders in the £2.6 trillion credit derivatives market to clean up their back offices and system controls yesterday, warning that too many companies were failing to deal with the rapid growth in the sector.

The Financial Services Authority told brokers and traders in the £2.6 trillion credit derivatives market to clean up their back offices and system controls yesterday, warning that too many companies were failing to deal with the rapid growth in the sector.

In a letter to the chief executives of all major participants in the sector, the FSA said it had become concerned after uncovering a high level of unsigned transaction confirmations within certain firms. In some cases, it added, transactions had remained unconfirmed for months.

Credit derivatives are financial instruments used to insure against companies defaulting on or restructuring their debt.

Gay Huey Evans, the FSA's capital markets sector leader, said: "The FSA requires all regulated firms to have in place appropriate systems and controls to enable them to ensure the smooth running of their businesses and maintain efficient, orderly and fair markets.

"Recent supervisory work has found that a number of firms in the fast-developing credit derivatives market are failing to resource their back-office functions adequately to allow them to keep pace with the growth of their front-office business."

The credit derivatives market, centred in London, grew by 44 per cent in the first six months of 2004. The British Bankers' Association estimates it will grow by a further 60 per cent over the next two years.

Ms Huey Evans added: "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."

Three years ago, Sir Howard Davies, then chairman of the FSA, expressed concerns about the risks embedded in credit derivatives. But no action was taken by the regulator in relation to the market.