10 October 2013

New Regulations and Collateral Requirements – Implications for the OTC Derivatives Market

The paper provides a snapshot of the changing collateral space and how this will impact the regulatory push to move over-the-counter (OTC) derivatives to CCPs. With continued quantitative easing (QE) by some central banks, price signals from the repo market indicate a shortage of good collateral. This paper focuses on the collateral demand in the OTC derivatives market as they move to central counterparties (CCPs) and suggests alternatives on how to reduce risk in this market.

There needs to be justification for creating new systemically important financial institutions (SIFIs) like CCPs, since it is not (yet) clear if SIFIs can be unwound. The proposed regulations disregard the existing netting bundles prevalent in this market which then leads to sizable collateral requirements—although many academic/consulting papers use simulations to show otherwise. Furthermore, some key exempted users (like the sovereigns) will keep afloat the sovereign/bank nexus that sow the seeds of moral hazard for a taxpayer bailout of CCPs. Some recent initiatives on the CCP resolution/recovery front may offset the likely burden on taxpayers, but has drawbacks too. Yet, under the rubric of transparency, a piece-meal compromise has taken off without global consensus on several key issues.

In summary, the proposed route of removing OTC derivatives from banks books creates new SIFIs, destroys the economics of netting on the books of the banks, silo(s) collateral and decreases collateral velocity, and increases the interconnectedness of the financial system. Alternately, if every user of OTC derivatives contributed their share of margin(s) when using OTC derivatives (relative to the proposed bifurcated “clearing” and “non-cleared” worlds including legacy trades that will not clear), the risk from derivatives at SIFIs would be eliminated. There would be no need for CCPs.

by Manmohan Singh

Download (1.13MB)

Call for Proposals

Current call for proposal submission window is closed. Stay tuned as another opportunity will be posted soon.

FAQ

The SWIFT Institute issues calls for research proposals on specific themes or topics on an on-going basis. Submissions are reviewed by the Advisory Council, and grants are awarded to support approved research proposals.
Proposals from prospective researchers must include a cover letter, CV, details of research experience, examples of published work, references, idea for research, methodology to be used, timeframe for completion, and expected output (e.g. working paper, presentation). Proposals should only be submitted in response to an issued Call for Proposal.
Once a sponsored research paper is ready to be published, the SWIFT Institute will publish it on its website as well as the academic journal repository SSRN. The SWIFT Institute will issue a press release on the paper and may even feature the newly published research in its quarterly newsletter. After the SWIFT Institute publishes the research, the research and its content belong to the researcher to publish, giving credit to the support given by the SWIFT Institute.

Submit your paper

If you have a paper that is of relevance to the financial industry and you would like it to be considered for publication on the SWIFT Institute website, please send us your request by using our Contact Form.

Contact Us