Simplifying CDSs for exchanges may add risks-ICAP

NEW YORK, Nov 10 (Reuters) - Credit derivative users could be exposed to greater risks if they are required to trade more standardized products on exchanges than otherwise fit their needs, ICAP (IAP.L: Quote, Profile, Research), an interdealer broker, said on Monday.

ICAP said it has approached regulators and central banks in the United States and Europe with proposals on how to improve liquidity and transparency and reduce operational risks in over-the-counter markets.

The paper comes amid some proposals to move the trading of the $47 trillion credit default swaps market onto exchanges, in a bid to promote greater standardization of contracts and more price transparency.

The move could backfire, however, by leaving investors or other participants with large basis risk, said Mark Yallop, group chief operating officer at ICAP, in a press briefing.

So-called basis risk occurs when investors use a security that are not a direct match on an asset to hedge the position, which in some circumstances can lead to greater losses due to the difference in the behavior or value of the two securities.

Credit default swaps are insurance-like contracts that are used to protect against a borrower defaulting on their debt. Because they are privately traded they can be customised to meet specific client needs.

ICAP said it supports the creation of a central counterparty for credit derivative trades, but added that an independent entity, which is not controlled by an exchange, would be more beneficial to the market.

"An exchange solution needlessly grants the exchange a monopoly on trade execution (which is usually accompanied by restricted access to clearing) which thereby leads to increased trading costs and risk and diminished flexibility," ICAP said in its paper.

ICAP also recommends that electronic trading of over-the-counter securities also be adopted more widely to enhance price transparency and simplify trading. (Reporting by Karen Brettell; Editing by Tom Hals)