Shaping Reforms and Business Models for the OTC Derivatives Market: Quo Vadis?
Centre for European Policy Studies (CEPS)
April 15, 2010
ECMI Research Report No. 5
Now that the worst of the financial storm is over, regulators are setting new strategies to deal with the systemic importance of the $427 trillion ($604 trillion) over-the-counter (OTC) derivatives market. This paper explores the three major sources of disruptive effects in OTC derivatives transactions: liquidity, counterparty risk and legal uncertainty. These risks affect the value chain of a typical derivative product and weaken the economic and legal rationale behind their widespread use. On the policy side, commitments have been made at G-20 level to draft uniform rules on a global scale “to build a safer financial system”. This paper finds, however, that in practice, the EU and US proposals lay out divergent roads to meet common objectives and the author warns that such divergences may encourage regulatory and supervisory arbitrages. Policy options currently under discussion may need further revision. For instance, centralisation of clearing on network infrastructures, as CCP's, can only be limited to a restricted group of eligible financial products. Mechanisms of adverse selction and moral hazard, then, may at any time affect the efficient functioning of these crucial infrastructures for financial markets.
Number of Pages in PDF File: 60
Keywords: OTC derivatives, central counterparty clearing (CCP), data repositories, collateral management, electronic trading platform, exchange, market transparency, systemic risk , financial and securities regulation, corporate finance, capital markets, financial crisis
JEL Classification: G10, G15, G18, G20, G24, G28
Date posted: April 20, 2010 ; Last revised: February 16, 2012