Swaps clearing houses can pose contagion risks - U.S. monitor

WASHINGTON (Reuters) - The U.S. monitor of financial stability will put clearing houses for the $710 trillion swaps market under its microscope this year, saying on Wednesday the centralized system could create contagion risks as well as concentration risks. In its annual report to Congress, the Office of Financial Research said a clearing house acting as a go-between in a swap "is a single point of vulnerability for failure and creates the potential for propagation of risks, potentially offsetting the advantage." Swaps, a form of derivatives, mushroomed before the financial crisis when they were lightly regulated. Since the 2007-09 credit meltdown most are routed through clearing houses that hold the collateral against potential default by one of the swap partners. In some instances, they also have enough cash on hand to cover a major default. Five of these intermediaries are considered "systemically important," meaning that they are "too big to fail." Using a central party to go between swap partners "increases price transparency and improves risk management, but it also can introduce concentration and contagion risks in replacing a network of two-way trading relationships," the office said. "In addition, central clearing can have the unintended consequence of creating incentives for market participants to obscure the costs of potential defaults and liquidation," it added. Specifically, the OFR said that swaps dealers can split their positions among multiple clearing houses, making it harder to gauge potential liquidation costs. Also, over time a clearing house will have increased exposure to the risk of failure by its largest member. The office, which was created in the 2010 Dodd-Frank Wall Street Reform law, does not have regulatory authority, but is charged with keeping close watch for disruptions that could lead to another financial crisis. It said this year it will identify and address gaps in data on clearing houses, potentially through a pilot collection program that would ultimately become permanent, in collaboration with regulators. It added that it will also develop ways to publish data on the clearing houses. Along the same lines, the office said it is still working with the main U.S. swaps regulator, the Commodities Future Trading Commission, to promote data standards in swaps reporting, saying that low-quality information is blocking "a comprehensive view of the markets." (Reporting by Lisa Lambert; Editing by Andrew Hay)