G20 Reforms are Limiting the Central Clearing of OTC Derivatives

Following the global financial crisis, the G20 implemented a number of crisis reforms for the over-the-counter (OTC) derivatives market. On Monday, the Financial Stability Board (FSB) and partners published the final report on Incentives to centrally clear OTC derivatives and how these reforms interact with the incentives.

Assisting the FSB was the Basel Committee on Banking Supervision (BCBS), the Committee on Payments Payments One of the bases of mediums of exchange in the modern world, a payment constitutes the transfer of a legal currency or equivalent from one party in exchange for goods or services to another entity. The payments industry has become a fixture of modern commerce, though the players involved and means of exchange have dramatically shifted over time.In particular, a party making a payment is referred to as a payer, with the payee reflecting the individual or entity receiving the payment. Most commonl One of the bases of mediums of exchange in the modern world, a payment constitutes the transfer of a legal currency or equivalent from one party in exchange for goods or services to another entity. The payments industry has become a fixture of modern commerce, though the players involved and means of exchange have dramatically shifted over time.In particular, a party making a payment is referred to as a payer, with the payee reflecting the individual or entity receiving the payment. Most commonl Read this Term and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO), collectively known as the Derivatives Assessment Team (DAT).

Central clearing, or central counterparty clearing, is a financial institution that reduces the counterparty, operational, settlement, market, legal and default risk for traders. This is because the entity becomes the counterpart to the buyer and seller, guaranteeing the terms of a trade even if one party pulls out of the agreement.

DAT report findings

The report found that the changes that have occurred on the OTC derivatives market post-crisis are consistent with the G20 Leaders’ objective. This is to promote central clearing as part of mitigating systemic risk and making the derivatives markets safer.

The capital, margin and clearing post-crisis reforms appear to give market participants an overall incentive to centrally clear. That is, at least for dealers and more active clients.

However, the report found that there are a number of factors, such as market Liquidity Liquidity The term liquidity refers to the process, speed, and ease of which a given asset or security can be converted into cash. Notably, liquidity surmises a retention in market price, with the most liquid assets representing cash.The most liquid asset of all is cash itself.· In economics, liquidity is defined by how efficiently and quickly an asset can be converted into usable cash without materially affecting its market price. · Nothing is more liquid than cash, while other assets represent The term liquidity refers to the process, speed, and ease of which a given asset or security can be converted into cash. Notably, liquidity surmises a retention in market price, with the most liquid assets representing cash.The most liquid asset of all is cash itself.· In economics, liquidity is defined by how efficiently and quickly an asset can be converted into usable cash without materially affecting its market price. · Nothing is more liquid than cash, while other assets represent Read this Term, counterparty credit risk management, and netting efficiencies, that are impacted by regulation in a way that it does not incentives market participants to centrally clear.

“The analysis suggests that, overall, the reforms are achieving their goals of promoting central clearing, especially for the most systemic market participants,” the statement added.

“This is consistent with the goal of reducing complexity and improving transparency and standardization in the OTC derivatives markets. Beyond the systemic core of the derivatives network of central counterparties (CCPs), dealers/clearing service providers and larger, more active clients, the incentives are less strong.”

The G20 has outlined the five areas of post-crisis reforms to OTC derivatives markers are trade reporting of OTC derivatives, central clearing of standardized OTC derivatives, exchange or electronic platform trading, where appropriate, of standardized OTC derivatives; higher capital requirements for non-centrally cleared derivatives; and initial and variation margin requirements for non-centrally cleared derivatives.

FSB framework

The report is the first of two evaluations under the FSB framework which seek to measure the effects of G20 financial regulatory reforms, specifically on how they impact incentives to centrally clear OTC derivatives.

According to a statement released by the FSB: “the findings of this evaluation report will inform relevant standard-setting bodies and, if warranted, could provide a basis for fine-tuning post-crisis reforms, bearing in mind the original objectives of the reforms. This does not imply a scaling back of those reforms or an undermining of members’ commitment to implement them.”