In the second half of last year the global market for credit derivatives expanded 39%, more slowly than it did in 2004, as regulators forced banks to tackle a backlog of paperwork that threatened the financial system's stability.
The market, dominated by credit-default swaps, which pay investors if a borrower defaults, increased to $17.3 trillion in the last six months of 2005, the International Swaps and Derivatives Association said Wednesday at its annual meeting in Singapore.
The growth rate for all of 2004 was 123%.
Federal Reserve Bank of New York President Timothy Geithner has demanded that firms improve processing after regulators discovered contracts left unsigned for weeks or months.
Officials also worry that there are not enough bonds available to settle contracts when companies default, and they urged banks to find ways to resolve the problem.
"There's been a certain amount of regulator scrutiny, which may have had some effect" on growth rates, Jonathan Moulds, the trade group's chairman, told reporters in Singapore. "I don't think it's dramatically significant."
Credit derivatives are the fastest-growing part of the $270 trillion market for derivatives, according to figures from the Bank for International Settlements. The market expanded more than fivefold in two years, according to the ISDA.
Last month Mr. Geithner said the 10 largest banks in the United States had about $600 billion of potential credit risk from derivatives holdings. That figure equals about 175% of their Tier 1 capital.
Last year the biggest credit-derivatives traders cut the average time to confirm transactions by nearly a third, to 16 days, the ISDA said.
This week the New York Fed said 14 of Wall Street's biggest banks have committed to cut the percentage of unsigned trades by 70% before July.
In a report published in July, Goldman Sachs Group Inc. managing director E. Gerald Corrigan recommended that some banks consider cutting trading until the backlog is reduced.
Malcolm Basing, the chairman of Primus Guaranty U.K. Ltd., which manages $13 billion of credit derivatives, was the ISDA's chairman from 1992 to 1993.
"If volumes have dropped because of the Fed, that's only temporary; these problems will be put right," Mr. Basing said in an interview at the trade group's conference. "Markets haven't tapped into all the underlying risk that can be managed using credit derivatives."
Credit-default swaps were developed to protect creditors against nonpayment of debts; some investors now use the instruments to bet on a company's credit quality. Contract buyers pay an annual fee and receive the full amount insured if a borrower defaults. Under the current system, buyers must deliver the defaulted loans or bonds to the insurer.
When Delphi Corp. collapsed in October, investors held insurance entitling them to more than 10 times the value of the auto-parts maker's bonds. Shortages of the notes needed to settle the contracts caused prices for the defaulted bonds to soar.
The ISDA, which represents 700 banks, securities firms, and institutional investors that use derivatives, has said it aims to have a process to settle credit derivatives in cash by June 20. The next meeting on the cash settlement proposals is scheduled for early next month.
The group's proposals include canceling credit-default swap trades that offset one another, to reduce the amount of overlapping bond and cash payments after a default.
"Where we were six to nine months ago was troubling, but not unusual. You tend to see the market itself grow faster than the infrastructure," David Viniar, the chief financial officer at Goldman Sachs, said in an interview Tuesday after his company released results for its fiscal first quarter, which ended Feb. 24. "We had exactly the same issue in the interest rate swaps market."
Contracts to swap between fixed and floating interest payments, the biggest part of the market, increased 6% in the second half of last year, to $213.2 trillion, the ISDA said. The first-half growth rate was 10%.
The market for equity derivatives, which let investors speculate on or guard against changes in stock prices, grew 15% in the second half, to $5.6 trillion, the group said. For the full year, the market grew 34%.
