View
225
Download
0
Category
Preview:
Citation preview
7/28/2019 Securities Regulation - Powerpoint Presentation
1/16
Presentation Assessment
Subject: Securities Regulation
7/28/2019 Securities Regulation - Powerpoint Presentation
2/16
Topic Question
Will a central counterparty (CCP) clearing system, for
certain classes of over-the-counter (OTC) derivatives,
reduce systemic risk in the financial system?
7/28/2019 Securities Regulation - Powerpoint Presentation
3/16
Thesis Statement
A CCP clearing system for certain classes of OTC derivative
will provide certain benefits. However, in isolation, a CCP will
not reduce the overall level of systemic risk in the financial
system.
7/28/2019 Securities Regulation - Powerpoint Presentation
4/16
What are OTC Derivatives?
A derivative is a contract whose value is derived from
something else such as the price of a share or
commodity, a certain benchmark interest rate, or even
the occurrence of a specified event such as a default.
OTC Derivatives are not traded on exchanges, instead
they are negotiated privately between financial
institutions on behalf of their clients and for themselves.
7/28/2019 Securities Regulation - Powerpoint Presentation
5/16
What is a CCP?
Currently most OTC derivative trades are bilateral. This is
the plate of spaghetti model that can create an
extremely complex web of interconnected counterparty
relations.
The idea behind a CCP is to reduce complexity by
creating a hub and spoke structure whereby an entity
sits in between the counterparties and assumes their
obligations. When trades are cleared through a CCP
each party is liable only to the CCP.
7/28/2019 Securities Regulation - Powerpoint Presentation
6/16
(Source: Council of Financial Regulators Discussion Paper, Central Clearing of OTC Derivatives in Australia, figure 2)
7/28/2019 Securities Regulation - Powerpoint Presentation
7/16
(Source: Council of Financial Regulators Discussion Paper, Central Clearing of OTC Derivatives in Australia, figure 2)
7/28/2019 Securities Regulation - Powerpoint Presentation
8/16
What is Systemic Risk?
The possibility that one financial institution becomes unable
to to meet its contractual obligations triggering a domino
effect of failures as one financial institution after another
goes bust. In such a scenario the continuing viability of the
current financial system comes under question.
7/28/2019 Securities Regulation - Powerpoint Presentation
9/16
Legal Context
Pittsburgh 2009 - G20 Group of Nations commitments
Intention of preventing a repeat of the GFC
Moving towards a system of CCP clearing for OTC derivatives wasone of these commitments, based on the belief that it would
reduce systemic risk.
In response to G20 commitments Australia amends Corporations
Act 2001 (Cth) in 2012
ASIC given the power to make derivative transaction rules that
require certain classes of derivatives to meet stipulated clearing
requirements (s 901A)
7/28/2019 Securities Regulation - Powerpoint Presentation
10/16
CCP Inability to Clear all OTC Derivatives
Only standardised OTC derivatives will require CCP clearing.
However, many are complex and individualised and thus
likely to fall outside any clearing requirements
Market participants may avoid CCP clearing requirements
via the alteration of standard contracts or regulatory
arbitrage.
Consequently, risk management benefits of a CCP will not
extend to those contracts it does not clear even though
they pose similar or possibly greater risks of loss to financial
institutions and contribute significantly to systemic risk.
7/28/2019 Securities Regulation - Powerpoint Presentation
11/16
Duplication of Industry Practice
A CCP will implement collateralisation requirements
Such requirements are already in place and would largely
be a duplication of current industry practice as set out by
the International Swaps and Derivatives Association (ISDA)
Thus the impact on reducing systemic risk would likely be
minimal
7/28/2019 Securities Regulation - Powerpoint Presentation
12/16
Concentration of Risk
A CCP will not reduce overall risk it will only alter its form.
Risk will be centralised into the CCP instead of it being
dispersed among a network of institutions
To reduce systemic risk institutions must be able to fail
without bringing down others with them, however a CCP
would itself be the ultimate Too Big to Fail (TBF) institution
7/28/2019 Securities Regulation - Powerpoint Presentation
13/16
Risk Management Issues
The nature of a CCPs role in assuming counterparty
obligations means it could fail during market
disturbances.
OTC derivative contracts can be illiquid and difficult toprice and this is especially so during stressed market
conditions
The use of quantitative models based on historical data
to used to measure risk and thus set margin and
collateral requirements can be misleading as was
demonstrated during the GFC.
7/28/2019 Securities Regulation - Powerpoint Presentation
14/16
Risk Management Issues
Using mark-to-market margin calls can fuel market
crashes as participants are forced to liquidate positions.
This creates a negative feedback loop and increases the
risk of a financial institution defaulting
7/28/2019 Securities Regulation - Powerpoint Presentation
15/16
Inability to Address Other factors
Regulation of securities of OTC derivatives through a
mechanism such as a CCP cannot address the other
factors which play a role in creating systemic Risk.
Such factors include leverage in the banking system and
incentive structures within the financial sector which
encourage risk taking.
7/28/2019 Securities Regulation - Powerpoint Presentation
16/16
Conclusion
A CCP clearing system for certain classes of OTC derivative
trades will provide certain benefits. However, in relation to
systemic risk in the financial system it will not reduce its overall
level.
Recommended