Thursday, October 22, 2009

Push for compromise on derivatives reform

Posted in the FT by Jeremy Grant:

Regulators on both sides of the Atlantic have agreed to study whether greater use of bilateral collateralisation could be expanded in over-the-counter derivatives markets as an alternative to sweeping imposition of greater capital charges.

The move will be greeted with relief by financial and corporate users of OTC derivatives. They have argued that reforms of the OTC derivatives markets risk going too far in mandating that banks and other intermediaries set aside extra cash on their balance sheets against the perceived risks of using many OTC derivatives.

The Obama administration and European Commission have thrown their weight behind greater use of capital requirements as one way to reduce risks in the financial system. Some OTC derivatives have been blamed for exacerbating last year’s financial crisis.

Another key part of the reforms is mandating greater use of clearing houses for OTC derivatives.

Paul Myners, financial services secretary to the UK Treasury, on Thursday said the UK and other jurisdictions had “secured the agreement of global over-the-counter derivatives supervisors for a major overhaul of bilateral collateralisation”.

Bilateral collateralisation is a process by which a trader post funds with an opposite party in a trade. In case of default by the opposite party, the trader keeps the collateral funds posted by its counterparty.

In clearing, such collateral is paid to the clearing house, which goes further by guaranteeing that the deal is completed in case of default by either party.

Collateralisation is already used in about 70 per cent of OTC derivative transactions.

But financial markets regulators in the US, UK and continental Europe will meet next week with participants in the industry to discuss ways to encourage greater use of the process. The meetings will involve the US Commodity Futures Trading Commission, the UK’s Financial Services Authority, as well as German and French authorities.

Lord Myners said: “At the global level, we are leading work to strengthen bilateral collateralisation. We have secured the agreement of global over-the-counter derivatives supervisors for a major overhaul of bilateral collateralisation and anticipate formal approval from industry next week.”

One person familiar with the plans said the aim was to see if it would be possible to “standardise” the use of bilateral collateralisation. A formal agreement on a way forward would be agreed in January.

Last month, Deutsche Börse, the German exchange and operator of a clearing house published a study saying that complex OTC derivatives trades that can not be processed through clearing houses should be collateralised as a matter of standard procedure to help safeguard the financial system.

Tony Freeman, director of industry relations at Omgeo, a post-trade service provider, said: “If the regulators have come to some conclusion that they are going to mandate bilateral collateralisation they have found a solution that is an extension of an existing solution and can be implemented really very quickly.”

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