Should Standardised OTC Derivatives Trading Be Mandated to Clear Through CCPs?
With all the discussion and regulatory malaise on OTC and the way to clear these trades going forward to support liquidity and advert risk in the system we wanted to know if mandatory clearing at CCPs was the way forward.
The impetus for the Global Financial Crisis (GFC) was the poor oversight and risk management of OTC derivatives by the banks. Previous financial shocks such as the Enron collapse precipitated the energy business to move away from bilateral trading to central clearing to see the likes of ICE Clear and ClearPort succeed. The destruction of wealth that had affected those far removed from these markets post-GFC has heralded an across-the-board reform of all OTC products in all corners of the globe. One of the central questions with respect to this reform is whether or not all standardized OTC derivatives trading should be cleared through a central counter party or a clearing house. We asked this question in our second opinion poll of the year that ran from mid February to the end of March and this was the outcome.
Nearly 74% of those votes felt that yes, some or all standardized OTC derivatives should go through a clearing house. Bad news for dealers but good news for clearing houses. However, a scenario such as this raises a lot of questions. What products are considered standard? Who will be exempt? What jurisdiction will clearing fall under? Will these CCPs become to big to fail? Will firms have enough money to post margin or how do you characterize a derivative in the first place? Clearly, there is no simple answer and the global nature of this kind of business exponentially complicates the issue. We would have to concur that there is room for some products to move to a CCP but we think it should be a measured approach with vanilla contracts moving across first. Much of the regulatory proposals are seeking to centrally clear by the end of the year but that isn’t realistic.
The third most popular response, though with only 14.04%, was the ‘No costs will go up’ camp. With the investment in risk management platforms, reporting systems and processing and storage of the sheer volume of transactions there is some merit to these voters response. We could look at it this way, however. The cost of the GFC would have more than paid the bill for the move of OTC trading to clearing houses. After the initial investment the visibility into positions and the ability to manage the risk will, in our opinion, over the long run reduce average costs to the industry and likely bring about some financial innovations not possible otherwise.
7.02% of respondents believed the moving to a CCP model wasn’t necessary. Perhaps, the added costs and the nature of some of these OTC products won’t make any changes to the market necessary. These will have to be identified as the reforms evolve. Lastly, with only 5.26% of voters not sure clearly most people have a view and those that don’t probably are waiting to get all the facts.
What is clear in the results of this opinion poll is that the industry feels that OTC derivatives trading needs to be managed differently than it has been in the past. The Singapore Exchange and Australian Securities Exchange along with data vendors and risk systems stand to benefit in the changes bearing down upon us.