Sunday, August 29, 2010

Market Infrastructure for Standard OTC Products

There is lot of discussion happening around OTC Derivatives and their future Market Infrastructure. The reason as we know – the meeting of G20 leaders on 25th September 2009 led to the decision - "All standardised OTC derivatives contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at latest. OTC derivatives contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements".

I have been also wondering how the Market Infrastructure for Regulated OTC market will turn out and thought of putting a very short note on how I perceive Market Infrastructure turning out in coming days.

The standard OTC products being cleared through CCP is a difficult to be imagined without being matched/reported at standard trading venues. So according to me, first priority for Regulators (like Europe Commission) will be to identify trading venues/trade repositories where the market participants can come and report the trades which can be matched/confirmed by their counterparties. The number of these trading venues should increase from current ones (like DTCC, ICE). This is important to give the market participants the flexibility to choose their venues. The other work for Regulators would be to define the structure of standardized products and authorize the type of OTC trades/products which can be reported at each trading venues.

For the trading venues, they need to get in contract with CCPs which can perform the clearing of these products. Again these CCPs need to be approved by the Regulators. Regulators need to approve the products which can be cleared on these CCPS. Trading venues need to also define the rules for member registration. The members like in current listed market can directly get registered with CCPs or get in contract with members of CCPs. Obviously on CCP side there are bigger items like – identification of clearing, risk management & collateral management models. These models need to be ratified and approved by Regulators.

I personally see interoperability of CCPs speeding up with standardised OTC products getting into regulated mode. I feel if this mission needs to succeed, the interoperability of CCPs needs to start in a massive way. So this is another aspect which CCPs need to look at and work on, as we are still struggling for a successful model on listed market.

Anyways it is already end of 2010. With the time line in hand, it will be really interesting how the market defines itself.