Manmohan SinghFrom: Clearing OTC Derivatives in Europe
Edited By: Bas Zebregs, Victor de Seriere, Rezah Stegeman, Patrick Pearson
This chapter evaluates the role of collateral in the over-the-counter (OTC) derivatives market and the associated drawbacks in the regulatory initiatives that propose to move these contracts to central counterparties (CCPs). The financial crisis following Lehman Brothers’ demise and the bailout of the American International Group (AIG) provided the impetus to move the lightly regulated OTC derivative contracts from bilateral clearing to CCPs. Prior to this move, CCPs were viewed under the rubric of payment systems. The debate about the future of financial regulation has heated up as regulators in both the United States and the European Union seek legislative approval to mitigate systemic risk associated with systemically important financial institutions (SIFIs), which include large banks and non-banks. In order to mitigate systemic risk that is due to counterparty credit risks and failures, either the users of derivative contracts will have to hold more collateral (or equivalent capital) from bilateral counterparties or margin will have to be posted to CCPs.