Tuesday, April 13, 2010

Central clearing is pricey (OTC swaps reform)

Original posted on Reuters:

Banks worldwide could have to post as much as $150 billion in collateral if central clearing, a widely recommended reform following the 2008 financial crisis, is required for over-the-counter derivatives, according to an IMF report.

Given the high up-front cost, "a gradual phase-in is warranted," the International Monetary Fund said in a report released on Tuesday. The initial cost could discourage voluntary adoption in the $450 trillion market, it said.

One type of OTC derivative, the credit default swap, was blamed for amplifying market distress in 2008, when the collapse of Lehman Brothers ushered in a deep, global recession. Clearinghouses, which guarantee payment and make terms of trade public, are regarded as a market stabilizer.

The report estimated up to $150 billion would be required initially from dealers if a large part of the private swaps market used clearinghouses. In many cases, dealers do not make such payments now in bilateral trading.

As an incentive for dealers to go to central clearing, "it may be necessary to consider a charge against their remaining bilateral positions," said the report.

A G20 communique last year suggested all standardized contracts should trade on regulated platforms and should go through central clearing by the end of 2012. Customized swaps should be subject to higher capital costs, the group of leading powers agreed.

Clearinghouses "deemed to be systemically important should have access to emergency central bank liquidity," said the report, as a protection against a large and damaging default. It cited European examples of such access.

In a sidebar, the report said three U.S. agencies regulate clearinghouses and concluded, "Ideally, the Federal Reserve or some other authority responsible for systemic risk should be given the oversight responsibility as a complementary function to prudential regulation and supervision."

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