Gerry Murphy
President, SunGard
Brokerage and Clearance
Over the past decade, the OTC derivatives market has grown dramatically. According to the Bank for International Settlements, the notional amount outstanding in the over-the-counter (OTC) derivatives market grew by 20.5% (compound annual growth rate) between 1998 and 2008. It far outpaced the listed market, which grew by 13.6% during the same 10 years.
With the events of the last 12 months, regulators have begun to scrutinize this market – in particular the credit default swaps market – in the hopes of increasing transparency and reducing counterparty risk. It’s not surprising that in the wake of this scrutiny, the central clearing counterparty (CCP) model has been suggested as a possible solution.
The traditional bi-lateral model may provide flexibility and creativity through custom contracts, as well as the potential for greater profits. However, central clearing can ease settlement, transfers and allocations, as well as protect the parties against default by their counterparty or a large section of the market.
While OTC volumes have shrunk, overall derivatives volumes remain strong, suggesting that the market is already shifting away from bi-lateral clearing toward the central clearing model. The organizations behind these clearinghouses are hoping to capitalize on this, as well as on the expected regulations, although the new rules are far from finalized.
Not everyone agrees that this model is the best way forward. A recent paper published by two academics from Stanford University argues that adding a central clearing counterparty for one class of derivatives, such as credit default swaps, can actually reduce netting efficiency and therefore lead to an increase in collateral demands and average exposure to counterparty default. Moreover, they maintain that whenever it is efficient to introduce a CCP, it cannot be efficient to introduce more than one CCP for the same class of derivatives.
As usual, the proof is in the market. Any CCP will only survive with the support of the buy and sell side, and that is by no means assured. The worst outcome would be a new system that is still risky but in a different way.
I’m interested in your perspective. Weigh in and have your say:
Do you agree with the Stanford University paper, or will the CCP model prove to be the right path toward transparency and reduced risk?