30 Oct 2009, Mark Pengelly, Risk magazine
Speakers at the Risk USA conference in New York in October raised concerns about central clearing - with JP Morgan Chase's chief risk officer even pointing to it as a possible source of the next financial crisis.
"We are probably sowing the seeds of a future crisis by putting all the risk of over-the-counter derivatives in one place. Inevitably, there will be one central counterparty that has some problems and triggers a crisis," remarked Barry Zubrow during a keynote address on October 28.
Regulatory efforts are under way in both Europe and the US to mandate central clearing of standardised over-the-counter derivatives contracts, an initiative that started in the credit default swap market. Zubrow's remarks reflect increasing discord among market participants over the plans.
Shortly before Zubrow's address, Tom Jasper, chief executive of Primus Guaranty, said: "I am very worried about the concentration of counterparty risk among what seems to be an ever-contracting group of counterparties in the market. Most people I talk to recognise that while clearing houses serve a very good purpose, they do not solve the counterparty risk issue. In fact, clearing houses concentrate counterparty risk."
Other complaints regarding central clearing for CDSs include the geographic separation that has resulted from the European Commission's (EC) drive to have its own regional clearer based within the European Union. JP Morgan's Zubrow notes this bifurcation could itself become a source of risk.
A further concern expressed during the conference is the threat of heated competition among central clearers, leading to catastrophically lax margin requirements. Regulators acknowledge there are likely to be only one or two successful central clearers for each region in the long term, but say they want to let market forces decide which ventures will be successful.
Even those involved with clearing houses admit central clearing is not a panacea. During the Futures Industry Association's annual expo in Chicago on October 21, Roger Liddell, chief executive of London-based LCH.Clearnet, remarked: "People shouldn't first assume clearing eliminates all problems. You have to ensure you have a very robust central counterparty and risk and default management system, particularly in the event of a market crisis."
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