The extent to which capital requirements will be used to encourage central clearing of European derivatives contracts remains unclear following European Commission (EC) proposals issued last week, according to brokerage industry body.
The recently launched EC consultation on counterparty credit risk sets out the broad changes that sell-side institutions will face in posting collateral for margin against over-the-counter (OTC) derivatives deals via central clearing or bilateral deals. But brokers have not been provided with the details required to calculate the precise difference in capital charges incurred.
As part of the Basel III reforms, the Basel Committee on Banking Supervision (BCBS) is significantly increasing the capital charges associated with OTC derivatives and securities financing transactions.
“Rather than zero, they are going to make it so you need more for cleared contracts and rather more for bilaterally settled contracts,” said Alex McDonald, CEO of the Wholesale Market Brokers Association. “The real issue will be around the metrics, when they come out.”
Under the EC's Capital Requirements Directive (CRD), additional incentives are being put in place to move OTC derivative contracts onto clearing by central counterparties (CCP), by requiring more capital for OTC derivatives not cleared by a CCP with the aim of reducing systemic risk. The proposed measures would also provide further incentives to strengthen the risk management of counterparty credit exposures.
McDonald notes that there is a political mandate to make the incentive to use central clearing as large as possible, but this may lead to a clash over the calculations used to determine the capital requirement. “BCBS is not politically driven – they come at it from a risk-weighted mathematical historical perspective, looking at historical risk factors. That raises the issue of how the gold plating might happen,” says McDonald.
The proposal document is intended to gather stakeholders' views on the capitalisation of bank exposures to CCPs and the treatment of incurred credit valuation adjustments, both of which were insufficiently explored in a February 2010 consultation, according to the EC. It also seeks feedback on the definitions of what constitutes a qualifying CCP, a qualifying transaction, access to a CCP and sets out an approach to capitalisation of default fund exposures.