I've let the ball drop on blogging for the past few weeks, but have been thinking a lot about the issues. The Post Trade Forum debate on
Are Clearing Houses Increasing Risk? will take place on Tuesday morning at the London Stock Exchange.
I've just finished my key note presentation for the debate, and I'm afraid I come down on the side of increasing risks. I've been studying derivatives clearing infrastructure for more than 25 years, going back to the market crash of 1987 when I was at the
New York Fed. I just can't see how imposing structured clearing and margin which fragments efficient bilateral netting arrangments and stresses global liquidity can improve the current system. I'm particularly worried about the liquidity implications for
cash management, safe assets as initial margin and default guarantee fund assets, and systemic encumbrance. At a time when credit to the real economy is already dampened, and banks are shrinking their balance sheets to fit the new Basel III capital requirements,
the transition to CCP clearing could contract credit and liquidity, and prove highly deflationary.
My concerns about CCP clearing increased dramatically after talking to some Buy Side end users at last month's Risk Annual Summit. My fellow panelists from corporations and asset managers were quite refreshing in admitting that they lack the expertise, systems,
legal resource and operations capability to make the transition to daily, multi-currency CCP margining with multiple CCPs fragementing the market by product and region. The same may be true of many banks, but they are much more reluctant to admit it openly
as any admission of weakness would draw an expensive supervisor-mandated audit of systems and processes.
The Buy Side also worried that the residual bilateral portfolios with their bank counterparties would be hit with much higher Credit Valuation Adjustments (CVAs) under the new Basel III rules that become effective January 2013. Even if they gain their objective
of an opt out of CCP clearing, they will be penalised with even higher initial margin requirements under IOSCO proposals that bilateral clearing should be punitive.
At a time when most governments are trying to jolly their banks into lending more to the real economy, Manmohan Singh of the IMF projected that the move to mandatory OTC clearing could be equivalent to a $2 trillion dollar margin call on 2nd tier banks, corporations
and asset managers. That would have a huge deflationary effect on credit and liquidity, and stall any recovery or deepen any recession.
So that's what I'm worrying about, but I'll provide much more detail on Tuesday morning. I'll post the slides after the event.