Banks trading in credit derivatives must maintain strong “Chinese walls” between lending and trading departments or they may face insider dealing charges, European banking groups are warning their members.

In particular, banks must not use private knowledge about corporate clients to trade instruments such as credit default swaps (CDS), says a report drawn up by five bodies including the International Swaps and Derivatives Association and the Loan Market Association.

The warning highlights the growing importance of credit derivatives in the global financial system and the challenges they pose to banks and regulators trying to build a functioning market infrastructure.

It has been partly triggered by the looming Market Abuse Directive in Europe, which will come into force on July 1.

This tightens the definition of insider trading in many European countries and potentially extends it to the credit derivatives market for the first time in some jurisdictions.

While no public cases of insider dealing in CDS have been brought against banks so far, the industry wants to raise standards now and to prevent regulators from becoming more heavy-handed in the future. “This is pre-emptive,” said one banker.

The industry report says: “[We need to] reassure market participants that the innovative risk management techniques and instruments that have emerged within the securities and credit derivatives market are used responsibly . . . and promote fair and competitive markets in which inappropriate use of non-public price-sensitive information is not tolerated.”

The issue of private information is highly sensitive for banks because they now play multiple roles in the credit derivatives sector, and the market itself is both fast-growing and opaque.

At the end of last year, the estimated total notional value of all credit derivatives was about $5,000bn, according to the British Bankers Association, of which about two thirds is CDS instruments, which let traders bet on the risk of corporate bond default. But pricing has often been opaque, since deals are conducted off public exchanges.

Moreover, many banks and institutions are trading CDS instruments in the same companies they finance sometimes because they want to reduce the risks to their own balance sheets.

This has previously prompted concern from some fund managers, such as Pimco.

However, large global banks with US operations say they already have good Chinese Walls, not least because US industry bodies adopted guidelines 18 months ago urging members to take action, in line with US regulatory practices.

But the US has hitherto had a far more extensive definition of insider trading than Europe and local European laws have not always covered instruments traded off public exchanges.

Consequently, industry observers suspect that some European banks may not have possessed such rigid Chinese walls.