Central counterparties (CCPs) will be forced to compete on risk to balance the costs of new regulation, potentially negating post-crisis Group of 20 aims to reduce systemic risk in the OTC derivatives market, Newedge’s global head of OTC Clearing, John Wilson, has said.
Adapting to new regulation, such as the European market infrastructure regulation (EMIR) and central securities depositary regulation (CDSR), will place higher costs on CCPs to clear OTC derivatives, which will be borne by end-investors, Wilson told the Sibos banking conference in Dubai on Monday.
“We hear regularly [CCPs] do not compete on risk management, but they all fundamentally compete on risk management because that’s the only thing they can compete on,” he said.
EMIR, like the US Dodd-Frank Act, is one of the key regulatory regimes developed in the wake of Lehman Brothers’ 2008 collapse, pushing for greater transparency in trading, clearing and reporting transactions in the traditionally opaque OTC derivatives market.
Likening CCPs to nuclear power plants, Wilson said CCPs could function extremely efficiently, but the nature of concentrating risk in these structures meant they could face major issues should another crisis hit.
“I have genuine concerns about the CCPs out there – that they know what they’re doing and whether they will be able to withstand a shock,” Wilson said.
CCPs have taken on the role banks held in traditional bilateral OTC derivatives trading, and would be bailed out by Europe’s central banks, including the Bank of England, should they face failure, Wilson warned.
For CCPs in Europe, the impending CSDR rules, and specifically leverage ratio requirements therein, will significantly increase clearing costs, forcing CCPs to alter business models and pass on costs to end-users.
Pre-empting rules
To manage this regulatory-driven period of change, CCPs and other infrastructure providers affected by G-20-led regulation must pre-empt final rules and adjust systems and processes according to regulatory outlines mooted before final rules.
This shifting regulatory environment, which is subject to cross-border rule fragmentation and frequent delays, has forced market participants to rely on adaptable governance structures.
“[Firms must] look at the themes coming out of the regulation, whether it be reporting or clearing and what the main aspects their systems and processes must deal with,” Angus Fletcher, head of market advocacy and business strategy for Deutsche Bank, said.
“They should have a good idea of these areas before final rules and be adaptable around the edges,” he said.
Stewart Macbeth, chief product development officer, DTCC Deriv/SERV, a trade repository operated by the Depositary Trust and Clearing Corporation, concurred, adding that firms must react to rules before they exist to remain competitive.
“We’ve had to make decisions before regulation is finalised about how we’re going to operate and design our infrastructure and then fit that into the regulatory framework presented,” Macbeth said.
Data division
As a trade repository, Deriv/SERV has attempted to respond to OTC derivatives reporting requirements with a global solution, but Macbeth said this was near impossible due to jurisdictions reacting in different ways to G-20 aims.
“We’ve had to respond within each jurisdiction with a localised framework and we believe that [approach] will continue. In this relatively simple area of trade reporting, there is an extensive amount of work to do,” he said.
As a leading trade depository, the DTCC has argued the introduction of competition to trade reporting will fragment data, making it harder to piece together disparate information sets to form the universal market view regulators initially envisioned.