In response to the events of 2007–09, the G20 has mandated a comprehensive reform of thestructure and transparency of over-the-counter (OTC) derivatives markets, which will result insignificant changes in the trading, clearing and reporting of transactions. This article explains whichcriteria are important when determining the eligibility for central clearing of OTC derivativesproducts. Suitability for mandatory central clearing is likely to depend on product and processstandardisation, but also on market liquidity. Liquidity is an important constraint and may requirecentral counterparties (CCPs) to modify risk management models. Further, systemic risk reductionbenefits associated with central clearing can only be achieved when CCPs have robust riskmanagement processes. Novation to CCPs is unlikely to be practical where operational processesare not automated, while risk modelling and default management become particularly challengingwhen products are illiquid. Therefore, there may be a natural boundary for the central clearingobligation, with less liquid products, or products for which operational process remain bespoke andless-automated, unlikely to be suitable for a central clearing obligation.
Thoughts on determining central clearing eligibility of OTC derivatives (500KB)
By Che Sidanius and Anne Wetherilt