On December 16, the UK Financial Services Authority and the UK Treasury published a joint paper entitled “Reforming OTC Derivative Markets” in which they set out the steps required to address the deficiencies with the over-the-counter (OTC) derivative markets highlighted by the financial crisis.
In summary, the paper sets out the following measures to be implemented and/or developed to address perceived systematic shortcomings in OTC derivative markets:
- Greater standardization of OTC derivatives contracts—This would enhance efficiency of operational processes and facilitate the use of central counterparty (CCP) clearing.
- More robust counterparty risk management—This would mean using CCP clearing for clearing eligible products and using proper arrangements and appropriate risk capital requirements for trades which are not centrally cleared.
- Consistent and high global standards for CCPs—Increased use of CCPs will heighten their systemic importance, so it is crucial that they are regulated to high standards which are consistently applied in major jurisdictions.
- International agreement as to which products are “clearing eligible”—Both regulators and CCPs will need to be involved in assessing which products are eligible for clearing.
- Capital charges to reflect appropriately the risks posed to the financial system—Non-centrally cleared trades should have proportionately higher charges.
- Registration of all relevant OTC derivative trades in a trade repository—This will facilitate regulators having access to the information they need to fulfill their regulatory responsibilities.
- Greater transparency of OTC trades to the market—This will aid price formation and market efficiency.
- On-exchange trading—With all of the above steps implemented, there will not be a need for mandating the trading of standardized derivatives on organized trading platforms.
Click here to read the paper in full.