Regulatory moves to force OTC derivative trades to go through central counterparties could just shift systemic risks to these CCPs and lead to more tax payer bailouts, according to a working paper published by the IMF.
Following the 2008 financial crisis lawmakers in the US and Europe have been pushing for OTC derivatives contracts to be cleared through CCPs in a bid to cut the systemic risk they pose and consequent moral hazard of tax payer bailouts.
However, the IMF paper's author Manmohan Singh says that the plans would simply increase fragmentation in the market because more CCPs will be created and they may also end up being 'too-big-to-fail' entities, which could need tax payer bailouts.
There are also several major cost hurdles to overcome in moving OTC derivatives to CCPS argues Singh, including a significant increase in collateral needs, the unbundling of some netted positions and the duplication of risk management teams at clearers.
These problems of interoperability and costs mean current proposals "seem unlikely to adequately reduce systemic risks or excess rents from OTC derivatives, and the likelihood of future taxpayer bailouts appears to remain significant," says the paper.
Singh says lawmakers should consider alternatives, including the possibility of a tax on derivative liabilities or even recasting the OTC market infrastructure as a public utility, although this would need action to stop cross-border regulatory arbitrage.
Singh's suggestions have been rejected by law firm Dewey & LeBoeuf, which calls for a "holistic approach and says a tax "is definitely not the answer, especially coming on top of transaction levies and increased capital charges for uncleared derivatives."
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