G30 proposes major clearance reforms and emphasises risk issues

The group said it hopes market participants will adopt the principles over a period of five to seven years, and the list of reforms includes an emphasis on a number of risk mitigation recommendations.The rapid growth of global financial markets combined with market shocks, such as September 11, have demonstrated that current clearing and settlement arrangements are vulnerable, the G30 said. “The risk recommendations address ongoing safety and stability concerns, stand on their own merits and require swift action,” the G30 added in a statement.

“Given [the] rapid growth of debt, equity and derivatives trading, the wrong combination of market shocks and financial dislocations might be sufficient to overtax the infrastructure on which the functioning global markets depend,” said Andrew Large, deputy chairman of the Bank of England and chairman of the G30 committee that has researched clearing and settlement issues for the past two years. "We are talking about the central nervous system of global finance, whose health is of vital economic significance.”

The G30 risk recommendations called for financial institutions to reinforce their risk management practices by establishing robust due diligence and counterparty risk management controls. Banks should also regularly review and test business continuity and disaster recovery plans. “Market participants should ensure that master agreements provide that upon the early termination of a transaction, or group of transactions, the determining party will have the flexibility to value such transactions by the method that is most likely to produce a commercially reasonable valuation at the time of termination,” the G30 report said.

Effectively, the G30 wants to encourage the world’s major private and central banks to develop a more integrated cross-border clearing and settlement system – much like Continuous Linked Settlement (CLS), the new industry initiative to cut settlement risk for foreign exchange, which went live late last year.

The G30 said its reforms will reap benefits for market participants, which currently have to contend with a myriad of clearing and settlement systems when conducting cross-border trades. Because of the five- to seven-year timeframe, the costs of implementing new technologies would not be prohibitive, as it is in keeping with the normal replacement cycles for systems and software, Large said.

Also speaking at the press conference at the Bank of England in London this morning, David Walker, G30 treasurer and senior advisor for Morgan Stanley in London, said securities trading in Europe, for example, typically involves around 20 different clearing and settlement models. As a result, an efficient system is now more urgently required than it ever was with the foreign exchange market, due to the range of asset classes involved, Walker added.