While the use of credit derivatives has substantially contributed to enhanced risk-sharing and is expected to have improved the resilience of the financial system, questions can be asked about the sustainability of the pace of growth in these markets as well as about their implications for the emergence of other forms of risk. Two issues in particular have surfaced in the course of the past year. First, the sheer complexity of many of the structured products introduced in the credit derivatives markets implies that there are potentially large risks for end-users who might not fully understand the time-varying risk profiles of such instruments. Indeed, as illustrated in several episodes of recent large corporate downgrades, the pricing of structured credit products might not adequately account for unanticipated changes in correlation structures among the assets incorporated in the underlying pools. Second, the rapid increase in trading volumes has stretched banks’ and dealers’ settlement systems and caused backlogs that could contribute to liquidity problems in a situation of increased trading activity. These problems could be particularly relevant for the European market, given the larger discrepancy in size between the cash bond market and the derivatives market than in the US. There are signs that, in accordance with the recommendations of the Counterparty Risk Management Group II report, many  BIS Review 50/2006  3  global banks have successfully worked towards solutions to these problems. However, it is rather widely acknowledged that pockets of vulnerability remain in these markets.
We have urged French banks, in conjunction with the national institute of statutory auditors, the CNCC, to provide detailed disclosures of their subprime exposures. A joint working group made up of staff from the Commission Bancaire, the Autorité des Marchés Financiers and the French Banking Federation has defined best practices in this area. Institutions have started implementing them in a satisfactory manner and practices should be further improved in the financial statements for first-half 2008. In 2009, the Basel Committee is planning to publish recommendations on information to be disseminated under the requirements of Pillar 3 of Basel II. In-depth discussions with banks led to a convergence of practices for asset valuation, including the priority on relying on prices and directly observable market data. Where banks have had to use valuation models because liquid prices disappeared in some markets, the recommendations deal with consideration of all risks – including liquidity risk and counterparty risk – and the rigorousness of the process for determining such prices. With regard to adapting the Basel II requirements, we are also playing a very active role in the various international working groups led by the Basel Committee to give greater consideration, where necessary, to the capital requirements related to some liquidity lines or to the securitisation rules. Finally, the crisis has highlighted the need for banks to improve their analysis, measurement and management of liquidity risk.