Regulation of OTC Derivatives Flashcards
What are the differences for derivative being cleared through CCP and OTC?
CCP is the clearing system that allows to increase the transparency of derivative exchange traded market by standardizing and ensuring the clearance of the contracts.
While OTC doesn’t have this requirements from clearing houses and exchange traded markets. If you buy CDS and you think you are hedged therefore you are avoiding risk is only true when your counter party fulfills the requirements of CDS.
So the Central counter party reduces this OTC risk by large extent.
What is the current position of regulation in OTC derivatives? What are the arguments for and against?
OTC derivatives are exempt from regulation under Commodity Futures Modernization act 2000 US, it is highly customized and involves no regulatory oversight rules and collateral requirement. However in May 2009 US Treasury launched proposal to increase regulatory oversight in OTC, because it has been identified as playing a particular huge role for recent crisis and potentially posses a systemic threat. We’ve seen that recent crisis was fueled by this OTC derivatives rather than CCP derivatives
Arguments for Derivatives:
Regulatory oversight increase in derivatives will increase corporate hedging costs and therefore overall corporate cost of capital. Moreover the theoretical argument for derivative instrument is to spread the risk of an asset across the market, by transferring risk whomever is able to afford through hedging. And these arguments always have been in place for in favor of derivatives
