Shearman & Sterling LLP | Financial Regulatory Developments Focus | Final Report on Incentives to Clear OTC Derivatives Published by Global Standard Setting Bodies
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  • Final Report on Incentives to Clear OTC Derivatives Published by Global Standard Setting Bodies
    11/19/2018
    A final joint report on the incentives to clear OTC derivatives has been published by the Financial Stability Board, the International Organization of Securities Commissions, the Basel Committee on Banking Supervision and the Committee on Payments and Market Infrastructures. The report is part of the FSB's post-implementation evaluation of the effects of the G20 financial regulatory reforms.

    The report sets out the results of an evaluation of the reforms that have been implemented to incentivize central clearing of OTC derivatives and outlines areas for further consideration by the global standard setting bodies. The reforms considered include mandatory clearing requirements, capital, liquidity and margin requirements, as well as the reforms to CCP resilience, recovery and resolution.

    The evaluation found that:
    • the changes observed in OTC derivatives markets are consistent with the G20 Leaders' objective of promoting central clearing as part of mitigating systemic risk and making derivatives markets safer.
    • the relevant post-crisis reforms, in particular the capital, margin and clearing reforms, taken together, appear to create an overall incentive, at least for dealers and larger and more active clients, to centrally clear OTC derivatives.
    • non-regulatory factors, such as market liquidity, counterparty credit risk management and netting efficiencies, are also important and can interact with regulatory factors to affect incentives to centrally clear.
    • some categories of clients have less strong incentives to use central clearing, and may have a lower degree of access to central clearing.
    • the provision of client clearing services is concentrated in a relatively small number of bank-affiliated clearing firms.
    • some aspects of regulatory reform may not incentivize provision of client clearing services.

    The following areas for further consideration are highlighted in the report:
    • The impact of the reforms on smaller non-systemically important market participants.
    • The interaction between initial margin and the leverage ratio, which lead to a disincentive for client clearing service providers to offer or expand client clearing because:
      • IM does not reduce the leverage ratio's exposure measure for derivatives; and
      • client IM held on a firm's balance sheet may increase the leverage ratio's exposure measure, even where margin must be segregated and there are restrictions on its use by the firm as a source of leverage.

    The Basel Committee is consulting on targeted revision of the leverage ratio exposure measure, proposing two possible options: (i) a treatment that would allow amounts of cash and non-cash IM received from a client to offset the potential future exposure of derivatives centrally cleared on the client's behalf; and (ii) a treatment that would align the treatment of client-cleared derivatives with the measurement as determined per the standardized approach to measuring counterparty credit risk exposures for risk-based capital requirements. The consultation closes on January 16, 2019.
    • The economics of client clearing and the relevant standards and their interaction with non-regulatory factors, including further quantitative analysis of the fixed costs associated with client clearing businesses, the structure of clearing fees, the allocation practices of firms, and the interaction of the relevant factors.

    The report states that each standard setting body is responsible for deciding whether and how to amend a particular standard.

    View the report.

    View details of the consultation paper.

    View details of the Basel Committee consultation on leverage ratio.

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