Testimony of Robert Pickel Chief Executive Officer, International Swaps and Derivatives Association Before the Committee on Agriculture U.S. House of Representatives December 8, 2008
Mr. Chairman and Members of the Committee: Thank you very much for inviting ISDA to testify at this follow-up hearing regarding credit derivatives. As you know from our previous meeting ISDA and the OTCderivatives industry are proud of the strength the OTC infrastructure has demonstrated during the recent turmoil, while at the same time being committed to working with Congress, regulators and within the industry to strengthen these markets still further. About ISDA ISDA, which represents participants in the privately negotiated derivatives industry, is the largest global financial trade association, bynumber of member firms. ISDA was chartered in 1985, and today has over 850 member institutions from 56 countries on six continents. These members include most of the world's major institutions that deal in privately negotiated derivatives, as well as many of the businesses, governmental entities and other end users that rely on over-the-counter derivatives to manage efficiently the financial marketrisks inherent in their core economic activities. Since its inception, ISDA has pioneered efforts to identify and reduce the sources of risk in the derivatives and risk management business. Among its most notable accomplishments are: developing the ISDA Master Agreement; publishing a wide range of related documentation materials and instruments covering a variety of transaction types; producinglegal opinions on the enforceability of netting and collateral arrangements; securing recognition of the risk-reducing effects of netting in determining capital requirements; promoting sound risk management practices; and advancing the understanding and treatment of derivatives and risk management from public policy and regulatory capital perspectives. Among other types of documentation ISDAproduces definitions related to credit default swaps. The Role CDS Play in the Credit Markets Credit default swaps (CDS) benefit the broader economy by facilitating lending and corporate finance activity, which is especially crucial in today's tight credit environment. They perform a valuable signaling function and allowing investors to express a view on the market. CDS provide a simple device for banksand other lenders to hedge the risks associated with lending to a particular company, group of companies or industry. Generally speaking, CDS hedge the risk that a borrower will default. Fundamentally, if a lender can be sure it will be made whole regardless of whether a borrower defaults, it is more likely to lend. CDS also free capital for further lending activity by, among other things,enabling lenders to effectively manage its regulatory capital requirements or by increasing a lender's credit limit with respect to a specific borrower or industry. Ultimately, CDS increase
liquidity in the banking industry because they enable banks to manage the credit risk inherent in lending. Because CDS limit the bank’s downside risk by passing it on to parties that seek such exposure, banks areable to lend more money to many more businesses. CDS thus significantly expand companies’ access to capital from bank lending; indeed, without this risk management option credit markets might be even more tightly constricted than the presently are. CDS also serve a valuable signaling function. CDS prices produce better and more timely information about the companies for whom a CDS market developsbecause CDS prices, unlike the credit ratings published by rating agencies, rely on market-based information about a company’s financial health. CDS prices reveal changes in credit conditions, giving insight to bankers, policymakers, investors and others about credit in real time, making it easier to manage and supervise traditional banking activities. The recent trend of basing term loan...
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