A new report examining over-the-counter (OTC) derivatives reform in Europe and the US suggests some 10% of current global OTC derivatives volumes could be wiped out by forthcoming legislation.
The report, from financial research firm Celent, examines the impact of the Dodd-Frank Act in the US and the European market infrastructure regulation (EMIR) in Europe – both of which seek to transfer a large proportion of OTC derivatives trading onto centrally-cleared platforms. Policy makers in both regions hope central clearing will help reduce systemic risk present in the OTC derivatives markets by reducing the possibility that default by a single large counterparty could paralyse the market.
The regulatory proposals follow principles outlined at the 2009 G20 summit in Pittsburgh, where political leaders and central bankers committed to the central clearing of all standardised derivatives, the reporting of all OTC derivatives to trade repositories and the trading of standardised OTC derivatives on regulated exchange-like electronic platforms where appropriate.
“People think that there will still be a place for customised trades after the reforms, but some of them do not seem to realise the full extent of the costs being introduced,” said Anshuman Jaswal, Celent analyst and author of the report. “When you consider the extra collateral requirements, together with increased reporting and compliance demands, the cost of connecting to central counterparties (CCPs) and the need in many cases to hire new staff for compliance, of course volumes are going to go down.”
Earlier in October, Celent pointed to the increased collateral management and margin requirements under Dodd-Frank as a major source of cost for buy-side market participants, estimating the cost of collateral across the main CCPs at US$1 trillion or higher.
This latest report provides more detail, estimating total IT spend to facilitate the new rules alone could reach US$1.95 billion during the 2012-2013 implementation period. It also suggests tier one banks can expect their initial expenditure to adapt to the rules to be within the US$150 million to US$300 million range in 2012 and beyond.
Much of the spending is expected to be undertaken by the new CCPs and clearing brokers to establish the connectivity needed to allow large-scale OTC derivatives clearing. CCPs will also have to deal with far greater derivatives trading volumes than before, while trading platforms will also need to expend resources to connect to new CCPs.
In total, Celent expects that around 60-65% of existing OTC trades will move to CCPs, with an eventual plateau being reached beyond which further standardisation is unlikely to take place. Jaswal also warns that, due to the current incomplete status of the rules, market participants will face a period of at least a year in which their exact obligations remain unclear.
“Market participants will have to prepare for a whole range of potential situations,” he said. “This is already causing confusion which is likely to continue. These rules are having a big impact in a remarkably short space of time.”
The Dodd-Frank Act has been delayed from its original July target date, following an announcement by Gary Gensler, chairman at US regulator the Commodity Futures Trading Commission, in September, signaling some of the key rules would not be implemented until 2012, including the final rules for swap execution facilities (SEFs). The regulation has come under attack from Craig Donohue, head of Chicago-based derivatives exchange CME Group, on the basis that it does not take sufficient account of the costs and benefits of the proposed new rules.
Meanwhile in Europe, EMIR is currently being discussed by the European Parliament, the Council of the European Union and the European Commission, and is expected to be adopted by year-end.