A clear danger ahead

As theregulators push us towards centralised clearing for OTC derivatives they mayactually be making the world distinctly less safe.

At face valueit makes obvious sense; if one party defaults the CCP steps in. As always,though, the problem lies in the detail but this time not too far below thesurface.

The first problemconcerns the efficient use of margin. As CCPs start to uncouple from theirparent exchanges and compete more directly with each other it’s only naturalfor them to start trying to differentiate more.

An obviousstep is to offset margin requirements from equivalent (but not fungible)products, especially given the opportunity cost of capital these days.

This could nowinclude OTC products and exchange-traded ones, say a Euro-Swap and a Bund. Thisis ok in principle, but ‘equivalent’ is very different from ’same’ and a raceto the bottom in this type of competitive activity will increase systemic riskrather than reduce it.

The secondproblem lies in post-trade and allocations. In derivatives this is complicatedenough, especially when the executing broker is different from the clearingbroker (or brokers) for the actual fund sub-accounts.

Now multiplythis complexity by the number of Sefs (or OTFs) that emerge, then multiply itagain by every clearing house and, finally, throw in the fact that there is noagreed sequence for the messages and you start to get a distinctly queasyfeeling.

I think I’ll keepmy hard-earned cash under my mattress