BIS Expects Growth in Central Clearing
The Bank for International Settlements said there is ample room for further expansion of central clearing as certain interest rate swaps will have to be cleared in Europe from next June.
A report from the BIS said there has been significant growth since the G20 leaders pushed for mandatory clearing of over-the-counter derivatives in 2009. Last year more than half of the notional amount outstanding of derivatives transactions was centrally cleared, almost twice the percentage in 2009.
Clarus Financial Technology said on its blog that in the US, cleared interest rate swap volumes last month were 25% higher than in November 2014.
The BIS expects this trend to continue. “A recent study by the FSB (2015) finds that, for most of the plain vanilla interest rate contracts, the amount centrally cleared could increase significantly in the next few years,” said the report. “Even larger increases could potentially take place for other contracts such as credit default swaps, for which the centrally cleared volume is currently quite low.”
Last week the European Securities and Markets Authority said firms in the European Union will have to centrally clear certain interest rate swaps from 21 June 2016.
Esma said in a statement: “This marks an important milestone in implementing the EU’s post-financial crisis’ derivatives regulation – the European Market Infrastructure Regulation (Emir) – and follows the G20 commitment to clear all standardised OTC derivative contracts, where appropriate, through central counterparties.”
From June the EU clearing obligation will cover certain classes of OTC interest rate derivatives denominated in the G4 currencies – euro, sterling, yen and US dollars. The EU clearing obligation will subsequently be extended to interest rate swaps in Norwegian kroner, Polish zloty and Swedish krona and index credit default swaps.
The BIS said economies of scale create incentives for concentration and vertical integration in central clearing due to high fixed costs. In addition the benefit of netting increases with a larger range of cleared instruments and markets as members can post less collateral. Studies have estimated that a CCP that clears all asset classes would need only 74% of the initial margin collateral required by separate CCPs for each asset class
The BIS report said: “At the end of 2014, two CCPs accounted for nearly 60% of the total volume of cleared transactions reported to the Red Book, a publication that compiles statistics covering centrally cleared transactions reported by members of the Committee on Payments and Market Infrastructures.”
In addition 83% of CCPs are directly owned or managed by the company operating the stock exchange.
The BIS warned that this concentration of the risk management of credit and liquidity risk in CCPs may affect system-wide market price and liquidity dynamics in ways that are not yet understood, even though the shift to central clearing reduces counterparty credit risk.
“It is possible that CCPs can buffer the system against relatively small shocks, at the risk of potentially amplifying larger ones,” said the BIS.
As a result there are ongoing discussions on the financial strength of individual CCPs and on ensuring the continued provision of clearing services if a CCP goes into recovery or resolution.
The European Association of CCP Clearing Houses tweeted: “Looking forward to an adequate macroprudential framework for #CCP #clearing.”
Featured image by makaule/Dollar Photo Club
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