BRUSSELS | European Union regulators called Friday for a clear plan on valuing some of the shadowy high-risk credit derivative investments that have played a key role in the global financial crisis.
Billions of dollars have been wiped off banks’ balance sheets in recent months on fears that some complex investments may be based on assets that are nearly worthless - such as housing loans that may not be paid back when a recession puts people out of work.
The market for derivatives, whose value has estimated at about $600 trillion, boomed in the past decade as investors sought new ways to parcel out risk. But few people really understood the securities. Billionaire investor Warren Buffett claimed he didn’t need to, dubbing them “financial weapons of mass destruction.”
EU financial services chief Charlie McCreevy called on national supervisors and the financial industry to agree on the real risks credit derivatives pose — and how they can be limited to prevent further losses unraveling.
“I would like to have, by the end of this year, concrete proposals as to how the risks from credit derivatives can be mitigated,” he said in a statement.
Mr. McCreevy said there is now a pressing need for a central clearing counterparty — or negotiator — to trade derivatives. Mr. McCreevy pointed to a vacuum in the system since the collapse of U.S. investment bank Lehman Brothers last month which negotiated many of the world’s derivative contracts.
“At $600 trillion, the size of derivatives markets today are such that we cannot let this over-the-counter market continue without adequate counterparty clearing,” he said.
Mr. McCreevy said this was urgent for credit default swaps, financial instruments that offer insurance for lenders worried about a borrower’s ability to pay them back. Lenders are due a substantial payout if a company goes bankrupt — as many large businesses have in recent weeks, including three Icelandic banks.
U.S. authorities are also pushing for more oversight of credit default swaps with Securities and Exchange Chairman Christopher Cox last month urging Congress to set out federal rules.
As much as $60 trillion may be owed on credit default swaps, Mr. McCreevy said — and it is not clear whether the money will be paid out and who is responsible for paying for it.