 Tony Freeman
Director of Industry Relations, EMEA
The financial crisis has brought the issues of risk and exposure to the fore and with that come the usual search for a scapegoat. The market has sat back, stared into its navel and decided it best to target the high-yielding and more esoteric investment strategies. First was the turn of the hedge funds and now the OTC markets are coined as the instruments at the heart of this financial downturn.
It is unreasonable for OTC markets to be blamed as the write down of sub-prime assets are a result of failed ratings models, excess leverage, and poor business practice on the part of investment and commercial banks. The financial crisis is inherently the result of the breakdown in our risk and audit procedures and years of banks sitting back and failing to adequately deal with what they knew was a problem.
Recent market turmoil has reinforced the case for robust post-trade processes. The speed at which a counterparty can implode – Lehman and Iceland and prime examples of this – and the opaque nature of many OTC instruments means that “systemic risk” has to be re-defined and the biggest systemic risk in today’s market is the lack of clarity about what risks actually exist and who is vulnerable to them.
The natural instinct will be to now demand that OTC markets move to exchange status, but as pointed out in a recent whitepaper by ICAP this is an impractical solution. OTC markets have fundamental and sound reasons to exist in parallel to exchange markets that are not vitiated by the current financial crisis. There are distinctive and logical reasons why OTC and exchange markets exist separately and the solution to the problem therefore does not necessarily lie in attempting to mandate the transfer of OTC trading onto exchanges.
The recent call for increased standardization in the derivatives space has also led to talks about the creation of a central clearing counterparty (CCP) to reduce the risk that market participants are exposed to.
While it is widely agreed that the Code of Conduct has succeeded in introducing pricing clarity, the market is not convinced that complex entities, such as CCP’s and CSD’s, can actually build appropriate levels of interoperability. Post trade processes such as clearing and settlement are not homogenous and where forced interoperability may actually increase risk in the market.
CCP’s lend themselves to more standardized trading contracts and it is impossible to create a standardized pricing and risk management model around products that are inherently bespoke. It is this bespoke and individual nature of OTC contracts that makes them much more attractive, and suitable, for hedging complex or non-standardised risks. Over the past decade the OTC markets have made a huge contribution to global risk.
The universal usage of post-trade infrastructures can standardize operational processes, harmonise risk processes and measure the amount of risk at a centralised level – thus reducing systemic risk – and as suggested in ICAP’s report, the affirmation and confirmation of all OTC trades in all markets needs to be automated and accelerated as close as possible to the trade date.
The topic of same day affirmation has been on the derivatives agenda for some time now and earlier this year the Operations Management Group sent a letter to Timothy Geithner, President of the Federal Reserve Bank of New York, calling for the creation a derivatives market that matches its trades on trade date.
Increased automation of post-trade processes and moves toward SDA can reduce the costs and risks in this part of the trade lifecycle and make the overall cycle of trade processing increasingly efficient.
While derivatives are flavor of the month, the confirmation and affirmation of trades on the day a trade has taken place, irrespective of what asset class is being examined, is a massively important issue for the financial industry to address, and the traditional asset classes also have a long way to go.
Back |
 |
|
|
