As previously discussed, worldwide regulators are increasingly favouring a move towards cleared contracts. Pressure to move away from bilateral OTC derivatives trades is based on the current market opaqueness, which exacerbates and contributes to systemic risk.

Central clearing has been shown to increase transparency and reduce a variety of risks within OTC derivatives markets. As a result, legislation is underway to mandate the central clearing of all suitable products.

As with all new reforms, there are a number of challenges associated with establishing this new paradigm in the OTC derivatives market. Despite the initial benefits in moving to wider central clearing of OTC derivatives, this change will mask considerable challenges that the industry is still facing. These include the costs associated with developing and maintaining a large number of dynamic exchange feeds, the operational risk costs, reconciling the collateral calls and margins and creating a clear link between product control and finance, to name just a few. 

Given the global nature of the OTC derivatives market, in my opinion, there remains a clear need for worldwide coordination to establish minimum international risk management standards to avoid regulatory arbitrage. 2011 will be an interesting year for OTC derivatives and the old adage of “harmonisation and consistency” across the different jurisdictions (EU-US-Asia) will need to be applied.