Basel iii Compliance Professionals Association (BiiiCPA)www.basel-iii-association.com
Since the provider of that protection may have to make a payment on theprotection contract, these products create a new source of creditexposure.Buyers of credit protection therefore need to maintain and enforce soundcounterparty credit risk management practices.While CDS and FG insurance products have quite different legalstructures, they perform similar economic functions.
The Joint Forum’s analysis identified the following issues as common to
both CDS and FG insurance products.Each contributed to the recent crisis or poses cross-sectoral systemic risk.
• Inadequate risk governance:
Sellers of credit protection did not and often could not (given theirexisting risk management infrastructure) adequately measure thepotential losses on their credit risk transfer activities.This was generally true in the CDS market and to a lesser extent in theregulated FG insurance market (where there is at least some financialreporting required by statute).
Buyers of protection did not properly assess sellers’ abili
ty to performunder the contracts, and they permitted imprudent concentrations of credit exposures to uncollateralised counterparties.
• Inadequate risk management practices:
Poor management of large counterparty credit risk exposures with CDSand FG insurance transactions contributed to financial instability anderoded market confidence. CDS dealers ramped up their portfoliosbeyond the capacity of their operational infrastructures.