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How to define standardised derivatives

Sunday 28 March 2010 - by Ed Lakin


However, there have been concerns voiced that to safely achieve standardised OTC trading on exchanges and other trading platforms and allow for CCP clearing, more needs to be considered by policymakers than simply looking to standardise legal and process aspects of instruments. The key issue is of the liquidity of instruments to either be traded on exchange, or cleared through a CCP.

OTC derivatives are, by their very nature, bespoke and tailored to the specific needs of counterparties so that they can provide a specific risk mitigation function. In the case of trading on exchange, an instrument may be standardised but this may create issues for exchanges when mandated, in particular as to whether there is real demand for it to be traded.

There is a concern that regulatory pressure to have more traded on exchange may force exchanges into trading instruments that are not suitable and that there is no demand for.

On the clearing side similar points have been made in that standardised contracts do not automatically lend themselves to being clearable. The European Association of Central Counterparty Clearing Houses makes it clear that when a CCP is assessing the eligibility of an instrument to be cleared the main considerations are:


• sufficient liquidity
• availability of market pricing
• robust management procedures for the CCP
• powers to allocate losses, and
• whether participant default can be withstood.

Furthermore they note that the question of standardisation does not per se arise. There is also a similar concern that they may be pushed into clearing instruments that do not adhere to their strict principles of applicability.

The G20’s deadline for reform is the end of 2012. Work on the legal and process standardisation is already underway, and the industry is leading the steer on this.

The timescale of seeking to mandate the trading of instrument and clearing, however, may be required to happen at a slower pace.


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READERS' COMMENTS
2010-09-20 09:08:27 | Andrew
Love the new design!

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