OTC Derivative Clearing Summary. Making Great Ideas Become Reality ”. OTC Derivatives – What has Changed?. The recent financial crisis, with the failure of major broker-dealers plus the near failure of a
Making Great Ideas Become Reality”
recent years and is now significantly larger than that of exchange-traded derivatives. One
of the key differences between these markets are that while exchange-traded derivatives
are fully transparent in terms of positions, prices, exposures and counter party risk reduction;
OTC derivatives are largely unregulated with respect to the disclosure of information, and information
available to market participants.
risk through a variety of methods, ranging from simple counter party credit limits to collateral or margin,
margin “calls”, and bilateral netting agreements. However, the financial crisis highlighted many
weaknesses in the bilateral OTC derivatives market, such as non-transparency, inherent counter
party risks and the danger of systemic risk.
servicing) is an immediate way of addressing the limitations. This will be accomplished by creating
more robust management of counter party risk, increased transparency and a reduction in a variety of
other associated risks for the OTC derivatives market, remove trade-by-trade counter party risk by
acting as the central hub and facilitator of every trade, protect against default through margin
requirements, reduce operations risk by standardizing, centralizing and creating automated trade
processing through a single entity, reduce capital requirements, facilitate multilateral netting helping to
reduce average exposure, and create positions that are market-to-market.
cleared contracts. Central clearing has been shown to increase transparency and reduce
a variety of risks for OTC derivatives markets. Legislation is therefore underway to
mandate the central clearing of all suitable products. Some of the areas covered by the new
regulations include; scope of derivatives covered, clearing and trading requirements, trade
repositories, capital and margin requirements and position limits.
There are a number of challenges associated with establishing this new OTC derivatives market including
the costs associated with developing and maintaining a large number of dynamic exchange feeds, the
operational risk costs, reconciling the collateral calls and margins, creating a new link between product
control and finance, implementing default management, provisions of balance sheet reporting, creating
new reconciliation requirements, providing full transparency around collateral, updating and extending
system integration, margining and reporting.
encouraged by a number of key considerations such as the need for transparency, liquidity and lower
counter party risk. Counter party risk is now far more important than ti was prior to 2008 and we see
a definite need to address the lack of transparency that pervades OTC derivatives markets.
The use of CCPs alone is not enough to ensure that the OTC derivatives markets operate
accurately and remain resilient. It is important to complement the CCPs with improvements in trading
and settlement infrastructure.
With respect to the implementation of the new OTC derivatives regulations, ‘Harmony and Consistency’
across the different jurisdictions around the world is a key condition to avoid participants from
exploiting weaknesses of the new reforms.