New York Fed Urges Greater Transparency for Swaps

Goldman Sachs Group Inc., JPMorgan Chase & Co. and other banking companies in the $605 trillion over-the-counter derivatives market should make swap prices more transparent, according to the Federal Reserve Bank of New York.

Derivatives regulation pending in Congress should support the use of electronic trading platforms for all market participants, the New York Fed said Thursday in a staff report.

In some cases, users should be required to employ a price-reporting system similar to one established for the corporate bond market in 2002, according to the report.

Electronic trading platforms "lower search costs by improving the ability of market participants to more quickly determine the range of prices at which they could potentially execute a trade, and to more quickly and easily identify a counterparty offering attractive terms," the report said.

A bill the House passed last year requires that most standard and actively traded OTC derivatives be executed on regulated platforms unless no trading system will accept them.

Wall Street banks have resisted making more price information public because the trades are among the most profitable areas for the firms.

The report was written by Theo Lubke, a senior vice president at the New York Fed; Darrell Duffie, a finance professor at Stanford University; and Ada Li, a New York Fed bank examiner.

When securities or derivatives are traded on exchanges — where investors can see real-time prices, rather than indicative prices sent by e-mail in the over-the-counter market — the amount that dealers make on each trade, known as the spread, can shrink.

Dealers have resisted mandates for trading on electronic platforms that are "tantamount to an exchange," Robert Pickel, then-chief executive officer of the International Swaps and Derivatives Association, said in an interview last year.

The top five U.S. commercial banks, including JPMorgan Chase, Goldman Sachs and Bank of America Corp., were on track through the second quarter to earn more than $35 billion in 2009 trading unregulated derivative contracts, according to a review of company filings with the Federal Reserve and people familiar with the banks' income sources.

A reporting system similar to the Financial Industry Regulatory Authority's Trade Reporting and Compliance Engine, or Trace, also could help investors to "shop around" for prices and more easily determine whether to accept bids and offers quoted by dealers, according to the report.

While such a system may not be as beneficial for the most customized contracts, "there is a wide range of actively traded derivatives for which Trace-like price reporting could offer substantial improvements in market efficiency," the authors wrote.

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