An interesting few days in London last week at the annual derivatives bash, IDX. Naturally much of the debate and discussion was on the impending collision of the OTC and exchange-traded worlds that Dodd-Frank and EMIR are determined to orchestrate. Unlike equities, the worlds of OTC and exchange-traded derivatives have gone merrily down parallel, but separate, tracks. The regulators (driven by their political masters) have decided, however, that the best thing for the industry as a whole is to move as many “dangerous” bilateral OTC contracts as possible onto exchange-traded, or at least centrally cleared, platforms.
This was evident during the exchange leaders’ panel where the CEOs of the major derivatives exchanges were enjoying the views from the moral high ground and basking in the warm glow of the regulators’ approval. Let’s hope they’re right, as the finance industry really can’t afford any more bad publicity. Two points in particular strike me. The first is that for some large buy-sides that trade mainly with other large risk averse institutions, a bilateral relationship is actually safer. They know exactly who they are dealing with and don’t have to worry about the creditworthiness of the other firms their collateral might interact with on a CCP. The second is that pretty much every exchange in Europe is seeking to set up a clearing venue for OTC products and engineer ways in which this can be used to offset margin against exchange-traded products.
But what happens if we ever do actually have to pull the clearing rip cord? Andreas Preuss (CEO Eurex) was asked if a “living will” existed for Eurex Clearing. He confirmed that yes, such a plan does exist showing that, in his mind at least, he and his colleagues are prepared to think the unthinkable. Let’s just hope the rest of us never have to read it.
I concur with the sentiments, one only has to look at the notional value of bilateral trades to see there is probably not enough capital in the system to implement a total CCP regime, or that the use of such capital through a CCP will be efficient.
Just look at how Berkshire structured its famous notional $38bn long term puts over world equity indexes, these trades may not have been possible under a CCP structure and as you note the counter-parties could have see less risk in them ex-CCP.