Central clearing & over-the-counter derivatives
The financial crisis revealed problems within the ‘over-the-counter’ (OTC) market, which is used for trading derivatives such as credit default swaps. These deals are negotiated and executed on a bilateral basis. Bilateral arrangements increase the risks on individual counterparties to a trade. It also means there can be insufficient visibility of the exposures that result from OTC trading.
The G20 seeks to address the risks in over-the-counter trading by imposing mandatory central clearing for standard derivatives. Central clearing involves a central counterparty (CCP) sitting between buyers and sellers. By dispensing with bilateral agreements, the CCP absorbs the risks facing individual firms and acts as the ‘circuit-breaker’ in the event of market stress.
However, greater central clearing in turn increases the systemic importance of CCPs. These need to be supervised effectively. The European Commission is therefore proposing new European Market Infrastructure Regulation (EMIR) that will:
- Mandate central clearing of eligible derivatives contracts, and strengthen market infrastructure standards;
- Create an EU legislative framework for central counterparties, so that shocks to markets are dampened rather than amplified; and
- Require OTC trades to be reported to electronic trade repositories
On 15 September 2010, the Commission adopted the European Market Infrastructure Regulation (EMIR) to address issues relating to OTC derivatives, central counterparties and trade repositories. For a copy of the Regulation, please see:
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