NY Fed welcomes fresh round of OTC targets

Dealers promise to clear vast majority of credit and interest-rate derivatives centrally

Fourteen major dealers have promised further improvements in the over-the-counter derivatives market in a letter sent yesterday to the Federal Reserve Bank of New York.

The letter follows a meeting at the New York Fed between market participants and international supervisors on January 14, and includes promises to improve standardisation and transparency across across credit, interest rates and equity derivatives. The dealers also promised to cut operational risk and strengthen processes around collateral - reducing the possibility for legal disputes.

In an earlier letter in September, dealers said they would aim to centrally clear 80% of new and historical credit derivatives trades. Now, this target has been raised to 85%. In interest rate derivatives, dealers are working to clear 90% of new eligible trades by the end of June, an increase from an original target of 70%. And, also by the end of June, they are aiming to collectively clear 75% of historical eligible interest rate trades - up from an original target of 60%.

In credit derivatives, the dealers plan to target index transactions that are not already eligible for central clearing, along with single-name components of these indexes. In interest rates, they will focus on zero-coupon swaps, single-currency basis swaps and extending the maximum tenor of trades that can be centrally cleared. Further commitments on enlarging the range of interest rate products that can be cleared will come before the end of 2010, the letter says. The dealers also promised to remove legal, regulatory, risk management and operational barriers to buy-side clearing, and might involve clearing houses for credit default swaps in credit derivatives determinations committees.

Many of the latest dealer goals on standardisation relate to equity derivatives - dealers are looking to expand and improve standard documentation for equity derivatives trades, including revamping the 2002 Equity Derivatives Definitions to include a wider set of payoffs and underlyings. More generally, further opportunities for standardisation will be considered across the three asset classes, the letter says.

On collateral, the letter identifies new objectives in the areas of portfolio reconciliation and dispute resolution. These include updating the industry's roadmap for collateral improvements and deadlines for extending the use of portfolio reconciliation. Targets include reconciliation with counterparties of more than 1,000 trades at least monthly by the end of June 2010. The letter adds that progress has been made in testing a new dispute resolution protocol for collateral disagreements, which is undergoing trial use. Dealers say they will give supervisors regular updates on the trial, with the intention of wrapping up the process by the end of September. The letter also makes a commitment to report on the top margin disputes of dealers to their supervisors by the end of May.

Elsewhere, operational targets centre on the interest rate and equity derivatives markets. They include a list of specific targets for improving the timeliness of electronic trade submission, confirmation and matching, including cutting down confirmation backlogs. In equity derivatives, this means the amount of outstanding confirmations older than 30 days must be cut to less than one day of three-month average trading volume by the end of June. In interest rates, dealers have agreed to bring down the amount of outstanding confirmations older than 30 days to a fifth of a day of three-month average trading volumes by the end of April.

Measures to promote transparency include reporting more transactions to OTC trade repositories. Dealers have also pledged to furnish supervisors directly with greater information about market transparency. By the end of March, dealers aim to give supervisors an inventory of existing forms of transparency in OTC credit, interest rate and equity derivatives markets. In the ensuing months, this will be followed up with an analysis of how transparency might be increased in these markets, what the costs and benefits would be and how they would fall on market participants. Dealers will also provide supervisors with transaction data to make their own assessments on transparency, the letter says.

As well as new deadlines, the letter includes a list of successes in meeting targets previously set by the industry. This includes successes around central clearing: more than 90% of new interdealer interest rate derivatives voumes and 90% of all interdealer credit derivatives volumes are now cleared, it claims.

Although more needs to be done, the letter serves to highlight the achievements that have already been made, says the International Swaps and Derivatives Association (Isda) in a statement. "While work remains to be done, actions taken to date have fundamentally changed the OTC derivatives markets for the better. Many of the measures, and central clearing in particular, serve to significantly reduce systemic risks," remarks Stephen O'Connor, chair of the Isda industry governance committee and managing director at Morgan Stanley.

This article first appeared on Risk.net.


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