Derivatives markets and central counterparties
Over-the-counter (OTC) derivatives are financial instruments typically negotiated bilaterally between counterparties rather than highly standardised and traded on traditional exchanges. In the lead up to the global financial crisis large volumes of outstanding bilateral transactions had created a complex and deeply interdependent network of exposures that ultimately contributed to a build-up of systemic risk. The stresses of the crisis exposed these risks: insufficient transparency regarding counterparty exposures; inadequate collateralisation practices; cumbersome operational processes; uncoordinated default management arrangements; and market misconduct concerns.
In response, the G20 Leaders agreed in 2009 to a comprehensive reform agenda for these markets, with the objectives of improving transparency, mitigating systemic risk, and protecting against market abuse.
To achieve these objectives, the G20 agreed that:
all OTC derivatives contracts should be reported to trade repositories (TRs);
all standardised contracts should be cleared through central counterparties (CCPs);
all standardised contracts should be traded on exchanges or electronic trading platforms, where appropriate; and
non-centrally cleared (bilateral) contracts should be subject to higher capital requirements and minimum margining requirements.
Implementing these reforms required significant changes to FSB member jurisdictions’ regulatory regimes. In many cases new legislative frameworks have been designed and implemented, followed by detailed rules and regulations to give effect to reforms.
Supporting these national efforts, international standard-setting bodies have reviewed or developed standards to be applied in relation to financial market infrastructure and market participants.
The FSB has been monitoring national reform efforts, and regularly publishes reports on progress towards implementation of the agreed commitments and objectives. It has reported on the effectiveness and broader effects of the reforms, and is undertaking a study of incentives to central clearing of OTC derivatives along with the standard-setting bodies. As well, it has worked with the standard-setting bodies to ensure that necessary international work is taking place as needed, and coordinating across groups where appropriate, The FSB has also undertaken work on aggregation of OTC derivatives data, and on governance arrangements for the unique transaction identifier (UTI) and unique product identifier (UPI) for OTC derivatives reports, two identifiers which are crucial for such aggregation.
The shift to central clearing has also further increased the systemic importance of CCPs. As a result the FSB has untaken work to ensure that CCPs can be successfully resolved without recourse to tax payer funding.