Share your views : Should Standardised OTC Derivatives Trading Be Mandated to Clear Through CCPs?
Transparency creates opportunity in an already strained lit world, markets could use an injection of new flow
Hell yes! The Central Clearing Party should be well regulated and have ample funding. Only real danger here is the “single point of failure” the CCP itself becomes. Don’t put all the eggs in one basket. CCPs should be user owned, user governed, not-for-profit, priced at cost, infrastructure providers that operate under substantial government regulation and oversight. Every participant should have a painfully large slug of capital invested on a “will call” as needed basis. I’m thinking direct ability to suck assets right out of the firm’s deposit accounts on a moments notice. Any firm gets in trouble at a CCP and the entire group is in prorata at jeopardy. All operations and computer systems distributed with the most robust anti terrorism design. Every participant pledges its life to make the clearing function actually clear, and after that full faith and resources of the government to bail it out and make good from there. Consider having two CCPs for each product cluster. Each with sufficient IT and operations resource to carry the full load. Pay 20% more than rock bottom full cost (with overhead). Use that extra 20% for extra safety, redundancy, auditing, etc. The entire thing needs to be bullet proof and totally above reproach.
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shouldn’t capital required be a function of risk rather than a blanket capital requirement? And, if the government is backing it won’t participants be inclined to take more risk? Just my 2 sense.
Here is a view from a “plumber”. Have not given it a whole lot of thought but here goes. Set up the CCP’s by product cluster, at least two per cluster, each with a max 50% share of market, each capable of carrying 100% of the load in a pinch. Let OFR / FRB / FSOC be the regulator in the U.S.
I’ve always admired how payroll taxes in the U.S. are deposited at banks and swept efficiently to the Treasury with no recourse – a bad check for example still gets swept, sorry no refunds! Use the same concept here, each trading entity deposits into a special account. They are able trade but can’t withdraw funds. Each account is valued each night (with provisions for day trading risk limiting). Everything past cash and highly marketable treasury securities get a an appropriate haircut for valuation. No complex assets are allowed in the accounts. If there is even a hint of trouble” they sweep those assets right out of the accounts and collect them at the Treasury on behalf of the CCP to fund pro rata any trouble.
The CCPs are at cost entities, no profit, run as an industry utility. They set the minimum value for each trading entity in its group – based on risk – with the final total amount of all deposits approved and blessed by the government oversight group. CCP requires and reviews the “Living Will” each member must annually file, again with oversight and auditing from the government. Transaction fees fund the CCP. Between the variable deposits, and the per transaction fees (based on volume) the “safety costs” line up fairy well with the systemic risk imposed.
The idea is to defease the full cost of systemic risk mitigation right back onto the industry itself. Government only steps in on a six sigma plus event that no one could possibly have envisioned. Prior to any taxpayer bail out, all firms in the industry, not just the failing one, take an immediate, painfully large hit.
Do not consolidate all the risk into too few CCPs. Frankly, I worry if DTCC may itself at some point be too big, and too much of a central point of failure. Pay the price and have clearing spread around geographically, technically, operationally and financially.
Have North America, EMEA, and Asia each “re-insure” each other, before any government, in any of those regions, do a bail out. Even then its at minimal cost to put the industry back into shape. The last thing we want is for the government to become the market maker of last resort and become direct owners of huge pools of complex assets.
Mandatory term limits on CCP heads and the government oversight regulators. No need to make any of those positions too cozy or incestuous. Staggered vacancies. Keep the whole thing clean. 100% transparent operations with ample granular level sunshine disclosure of all operations to the public.
BTW, with the new LEIs and perhaps two new years into this it should be child’s play to choke off any trader who has filed for bankruptcy or reorg. Just shut off those LEIs intra day (i.e. the LEI registrar database simply broadcasts “this LEI is now suspended” to all subscribers. All trades with that party then cease. CCP then makes a very current assessment “do we need to draw in centrally any of the assets from our deposit accounts to mop up?”
There is no perfect solution. Increasing regulation will undoubtedly translate to a higher cost of doing business. The entire system here however might actually be a nice boost for the industry.
In the “old days” you had Beta exposure (direct correlation to the immediate trading market), Alpha (firm or credit specific factors) and Residual Risk. Now days we add an additional negative factor – exposure to the overall financial system systemic risk. With better regulation, and more fungible (and better understood) products that Systemic risk factor exposure goes dramatically down. The entire market expected return grows. That’s the type of thing the entire industry could totally celebrate!
Seems that you want to penalize the HFT players with transaction based fees. The risk they pose to the market is measured in microseconds. Wouldn’t a risk based fee make more sense. I make one trade per year but the risk on the trade is enormous but pay less than low latency arb strategist? Some of the other items sound interesting and are worthy points
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