New laws will be needed in the US and Europe to support the introduction of central clearing of credit default swap (CDS) trades, according to a study published yesterday by the International Swaps and Derivatives Association.
According to the report, produced jointly by Isda and a group of dealer and buy-side representatives, in a worst-case scenario - the insolvency of one of the clearing members of a central counterparty (CCP), as happened with the collapse of Lehman Brothers -customers risked finding their margin payments inaccessible, as they would become entangled in the insolvency process. Different jurisdictions have different laws governing margin custody, with only one CCP allowing individual customer margin accounts - thought to make recovery easier - rather than one catch-all omnibus customer account.
While all the CCP proposals represent an improvement on the current counterparty risk in the uncleared over-the-counter CDS market, "no proposal is perfect in its current form. All of the proposals could benefit to a greater or lesser degree from legislative or regulatory changes to enhance the customer protection analysis".
In particular, some clearing members require clients to transfer title of assets posted as margin, making their recovery in the event of an insolvency much more difficult - customers would also benefit from using a third-party custodian rather than the clearing institution, as this would insulate them from much of the risk involved in an insolvency. Better segregation of customer margin would also make contracts more portable, or transferrable from one clearing institution to another, the report added.
Both US and European regulators are addressing these issues. In particular, the report said, the market needed clearer rules on the treatment of margin, more power for CCPs to transfer customer positions from one dealer to another, and guarantees of fast access to margin assets in the event of an insolvency. But it warned that the new rules could also make the CDS market slower and more costly.
More on Credit Risk
A copula-based model for wrong way risk
A new product could smoothe the gap between capital and accounting rules
The Basel Committee on Banking Supervision has introduced strict regulatory guidance on how to validate and backtest internal model methods for credit exposure. Fabrizio Anfuso, Dimitrios Karyampas ...
Adjoint algorithmic differentiation is one of the principal innovations in risk management in recent times. Luca Capriotti and Jacky Lee show how this technique can be used to compute real-time risk...
Sign up for Risk.net email alerts
Sponsored video: Tradeweb
Multifonds talks to Custody Risk on being nominated for the Post-Trade Technology Vendor of the Year at the Custody Risk Awards 2014
Sponsored webinar: IBM Risk Analytics
Nominated for two technology awards
There are no comments submitted yet. Do you have an interesting opinion? Then be the first to post a comment.