Janet YellenPRICE CHAMBERS
Having already won the battle to create central clearing systems for derivatives, major regulators are now pushing for tougher margin requirements.
Some background: under the new rules for central counterparties, which will start up this year, financial institutions who trade derivatives are already required to post margin, a form of collateral, to protect against losses if their trades go bad.
But there's a big chunk of derivatives trades that won't be centrally cleared, and the big push is to make them do the same.
You see, when the G20 announced its goals for central clearing, it simply requested that only sufficiently liquid and standardized derivatives be cleared. The global body acknowledged that many derivatives do not fit this bill, and said "it does not make sense to push transactions into [clearing systems] that do not fit these characteristics."
So you can understand why such regulators as the Bank for International Settlements now want to impose margin requirements for the trillions of derivatives that are still executed under the old, risky model. In a paper last summer, global oversight groups argued that "these non-centrally-cleared derivatives, which total hundreds of trillions of dollars of notional amounts will pose the same type of systemic contagion and spillover risks that materialized in the recent financial crisis." In turn, the want margins up front for all types of derivatives: interest rate, credit, equity, foreign exchange and commodity.
Support for this proposal escalated last week when Janet Yellen, vice-chairwoman of the U.S. Federal Reserve, gave a speech that argued in favour of margin requirements for the more exotic derivatives.
Now the industry's pushing back. A trio of groups, including the International Swaps and Derivatives Association, put together a letter that states "the proposed [margin] framework would significantly impact liquidity in the OTC derivative markets. In so doing, it could harm important sectors of the global economy and potentially threaten, rather than strengthen, the global financial system."
They argue it's simply too hard to find so much liquid, high-quality collateral, and stress that its limited supply "could result in a withdrawal of market-makers in OTC derivative markets such as interest rate options or cross-currency swaps and could cause a liquidity collapse in these markets."
However, they aren't against all forms of margin. In fact, the trio supports what is known as variation margin, which protects the parties from changes in the mark-to-market value of the contract after the trade was executed. (Whereas regulators want up-front collateral.)
Although it's still early days, given the growing regulatory power around the world, particularly in the U.S., it looks like the industry could lose another round.
Have your say: Should margin requirements be imposed?
Tim Kiladze