Allowing broader direct access to central counterparties (CCPs) as part of the migration of OTC derivatives onto exchange could increase systemic risk and weaken the robustness of clearing houses, a new paper has warned.
While new G20-endorsed regulations requiring OTC derivatives to be centrally cleared are intended to increase the safety and resilience of the global financial system, a white paper from the Bank for International Settlements (BIS) says achieving these objectives depends on whether market participants obtain access to central clearing directly or indirectly.
Although the BIS believes direct access by market participants to CCPs could increase competition and efficiency through choice and cost benefits, it warns against the concentration of risk if OTC derivatives clearing remains dominated by between five and 15 dealers.
“While the access policies of CCPs and new laws and regulations governing them are continuing to adjust to the new era of mandatory clearing, such concentration remains a relevant issue,” the paper asserted.
To meet mandatory clearing requirements laid down by the G20, market participants will need to access CCPs either as direct clearing members or indirectly through direct clearing members.
“Increasing direct participation would require appropriate modifications in the default management process to ensure that risks to the CCP are appropriately managed,” the paper warned. “Such modifications could well increase the complexity of the process.”
The paper adds that indirect clearing arrangements could help broaden access to clearing houses, but effective segregation and portability of positions will be needed to reduce systemic risk.
Establishing domestic CCPs would help local supervisory authorities exercise oversight and perform crisis management and resolution if required, but the paper notes that such entities might suffer from limited scale. Moreover, oversight by local regulators may cramp global regulatory coordination of systemically important institutions.
“This interest may be particularly strong in jurisdictions and markets where a large part of the trading volume is provided by local institutions rather than global dealers,” the paper said. “However, even a decentralised clearing configuration would still require international cooperation to prevent domestic CCPs from competing on the basis of lower risk management standards and to avoid the propagation of systemic risk.”
The BIS report was established by a study group chaired by Timothy Lane, deputy governor for the Bank of Canada.
Nasdaq OMX enhances risk management ahead of new swaps rules
Nasdaq OMX Nordic, operator of domestic markets in Denmark, Finland and Sweden, has launched Genium Risk, a new solution to help members efficiently manage their collateral requirements as new derivatives rules emerge.
Genium Risk sits at the exchange’s clearing house – Nasdaq OMX Clearing – and provides new real-time tools to monitor risk and manage derivatives clearing obligations. The solution also incorporates capital efficient risk models for fixed income and equities to help members optimise their use of collateral.
“Our clearing house will have Europe’s first risk management system capable of integrating all asset classes, and with the ability to handle both OTC and exchange-traded instruments,” said Hans-Ole Jochumsen, president of Nasdaq OMX Nordic. “Genium Risk is the foundation for growing our clearing business, as well as enabling us to launch risk management products to external clearing houses and members.”
The exchange says that Genium Risk has been designed to meet clients’ needs following the imminent introduction of new rules that will require OTC derivatives to be standardised so that they can be traded on exchange and centrally cleared. This includes a new cash flow margin tool for fixed income instruments that enhances clearing efficiency while improving risk management functionality.
The new legislation – enacted via the Dodd-Frank Act in the US and the European markets infrastructure directive – will, among other things, impose a more stringent and formalised collateral regime for managing collateral requirements.
“Our main ambition has been to make Genium Risk as flexible as possible, allowing a high degree of customisation,” says Fredrik Ekström, vice president of risk management at Nasdaq OMX. “By being able to customise risk models and risk parameters for different types of asset classes and credit risks, the risk measures can be much more accurate.”
Currently, fixed income derivatives and equities derivatives are handled by the Genium Risk, with commodities expected to migrate to the new platform in March 2012.