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Credit derivatives: Trading backlog back again

What was hailed as a great success for the credit derivatives market, the tackling of the unconfirmed transaction backlog, has turned out to be far from a mission accomplished.

A spike in credit default swap volumes in July has exposed weaknesses in dealers’ ability to process trades in a timely fashion. Once again regulators, led by the Federal Reserve Bank of New York, are expressing concern over what looks like a resurgence of the backlog mess that first caught their attention in 2005.

Recent CDS market metrics published by the New York Fed show a massive burst of volumes in July, followed by an uptick in unconfirmed trades (see graph). Despite all the resources thrown at this problem by the banks that signed up to the so-called Corrigan letter in 2005 describing how they intended to resolve the unconfirmed trades, data show the backlog has been creeping up slowly since December 2006.

Credit derivatives

Outstanding confirmations

Source: MarkIt

Unconfirmed trades had come down from near the 12,000 mark in 2005 to about 2,000 in 2006. Banks were able to get these numbers down by automating their CDS trading systems, manually clearing up trades in a series of industry lock-ins and increasing the back-office operations staff charged with sorting out mismatched trades.

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