FIA, the Institute of International Finance (IIF), and the Global Financial Markets Association (GFMA) filed a response to the consultative report of the Derivatives Assessment Team (DAT) on “Incentives to centrally clear over-the-counter (OTC) derivatives” (DAT Report). The Associations agree with the DAT’s findings that there are impediments to accessing central clearing and urge global regulators to take action. Regulatory capital treatment of banks’ clearing activity is the key constraint on client clearing capacity by service providers, according to the response.
Further, the Associations’ assert that the current capital regime overstates the risks of client clearing, which are modest. This regulatory capital treatment increases the costs of providing client clearing services and thereby limits the amount and types of derivative positions and types of clients that banks are able to clear.
Clearing of derivatives increases the safety and soundness of the financial system, and global regulators have adopted rules that requires greater clearing of derivatives. However, other post-crisis regulations have worked at cross-purposes with the G20 clearing reforms by significantly constraining client clearing capacity. This constraint on capacity has threatened the viability of porting in a default scenario.
Specifically, in response to DAT Report, the Associations urged that the capital regime should be corrected in the following ways:
- The leverage ratio should be amended to recognize the exposure-reducing effect of client initial margin.
- Jurisdictions that have focused on notional-based approaches such as the current exposure method (CEM) to calculate risk-weighted assets under the standardized approach and exposure under the leverage ratio should adopt the standardized approach to counterparty credit risk (SA-CCR) with appropriate modifications.
- SA-CCR should be modified to recalibrate the excessively conservative alpha multiplier and correlation assumptions, and recognize the effect of initial margin more meaningfully.
- The G-SIB surcharge should be amended to recognize that the principal-to-principal model of clearing does not create more complexity or interconnectedness than the agency model of clearing, and to provide for lower systemic risk scores for cleared derivatives compared to uncleared trades.
The corrections contained in the Associations’ detailed response would reduce disincentives for banks to provide client clearing, improve clients’ access to clearing services, and help achieve the G20 goals. The Associations say the DAT should endorse these changes to the international standard-setting bodies and national regulators in its final report.
