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 John Burchenal
Executive Director, Market Growth
OTC derivatives markets operated under the radar of most regulators and politicians until the economic crisis took root and the public need someone or something to blame. Derivatives were a natural scapegoat because their complexity and perceived complicity in the melt down. Now politicians have the OTC industry squarely in their crosshairs to the extent that some are calling for it to be elimiminated entirely. One thing is for certain; any efforts being undertaken by the industry now to make voluntary changes (such as the Fed Letter Commitments) will not stand alone. They most certainly will be supplemented by Congress and regulatory bodies such as the Fed and the SEC. So far, existing proposals cover only the two extremes: to completely take away the OTC market in the U.S. and move everything to exchanges; or to keep the OTC markets intact and make a few cosmetic adjustments.
OTC derivatives are critical to the effective functioning of the global financial system. They are valuable tools to manage and mitigate risk for global institutional investors, corporations and governments. Derivative instruments themselves are do not carry risk. They transfer existing risk from one party to another. Like other OTC markets like fixed income, the OTC derivative markets would benefit greatly from increased transparency. Reform is desirable but only in a way where OTC markets are made more transparent and risk-managed more effectively. Central Counterparties are an effective means to mitigate counterparty risk and provide systemic regulators a clear view of overall risk while transactions repositories like DTCC’s Trade Information Warehouse provides transparency and operation risk mitigation. . Additional benefits can be achieved through rigorous risk management and automation of trade and post-trade processes. However, at this point, the choice of which route to take may no longer be ours.
The era of self-regulation of these markets may be over, we should not throw up our hands and assume there is no way to influence the outcome of congressional/regulatory action. Market participants should continue to make their voices heard to make sure that any legislation passed is feasible and realistic and doesn’t throw the baby out with the bathwater. Uneven or ill conceived regulation could result in making our markets less competitive resulting in the flight of capital and jobs to friendlier jurisdictions. What’s most important is that all market participants work together; across all sections of the market. Ultimately, financial institutions are commercial entities driven by creating value for shareholders, whereas central authorities can be very focused on short term political gain. The only way to balance these perspectives is for all voices to be heard. Speak up!
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