Role of central counterparties and processing of OTC derivatives

Part III – Some loud thinking on their future roles

Performance targets for central clearing

Senior Managements of leading dealers and buy-side institutions have conveyed to the Federal Reserve Bank of New York that they are actively engaging with CCPs to broaden the range of cleared products and market participants. They have also confirmed that they fully understand and support that CCPs will be regulated with particular emphasis on financial strength to absorb market shocks including bankruptcy of a major market participant. As CCPs expand their offerings, they will work with supervisors to deliver a set of performance targets for CCP usage by August 31, 2009.

Competitive clearing

There is a felt need in the market place to derive highest value at low cost and this is only possible by encouraging competitive clearing. The objectives of a competitive clearing are

  • To provide counterparties with more flexibility and freedom of choice to select their central counterparty including to keep their current clearing arrangements if they so desire
  • To ensure that the central counterparty services are of the highest quality
  • To deliver at the lowest price through open competition between central counterparties
  • To enable central counterparties to operate on equal terms, i.e. neither CCP will operate as a sub CCP of the other
  • To provide solutions based on existing and or proposed infrastructure to reduce the impact for all stakeholders wherever possible
  • To make no difference to one party whether their trading counterparty is using the same CCP or different one.

Is a global CCP desirable?

In the private sector, greater financial discipline at individual institutions must be reinforced by a renewed commitment to collective discipline in the spirit of elevated financial statesmanship that recognizes that there are circumstances in which individual institutions must be prepared to put aside specific interests in the name of common interest. Such a commitment may require market participants to (a) to make costly investments in infrastructure (human capital and technology and (b) change business processes, and accept changes to market practices, that in the past have generated sizeable revenues but at the cost of weakening the underlying foundation of the markets. Costly as these reforms will be those costs will be minuscule compared to the hundreds of billions of dollars of write downs experienced by financial institutions in recent months to say nothing of the economic dislocations and distortions triggered by the crisis.

At first sight, a global CCP is most desirable as it will be characterized by economies of scale and scope. In normal times, the concerns could be – static vs. dynamic efficiency, regulatory and supervisory differences and reliance on third country authorities. However in a crisis situation, limits to central bank emergency liquidity provision beyond currency area, single point of failure and legal risks in case of default (access to assets) can be overcome through this global CCP.

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