class="MsoNormal">We keep hearing that the risk in over-the-counter (OTC) derivatives can be dramatically reduced through centralized clearing facilities. But how would that work?
class="MsoNormal">Clearing facilities mitigate risk by netting out positions and putting collateral behind deals. But when we're talking about current numbers -- $700 trillion in notional values outstanding and $3.7 quadrillion of annual notional turnover in 2010 -- how much collateral is that in dollars?
class="MsoNormal">The World Federation of Exchanges wanted to know that, too, as well as the best way to implement the new rules affecting OTC derivatives. As the representative for regulated stock and derivative exchanges, the WFE could be viewed as looking to advance its own position. But the group's Deputy Secretary General, Peter Clifford, told Institutional Investor on a call from his office in Paris that, "We're not arguing against the OTC market in any way. It's just a question of making it safe." And safety is not a word associated with OTC lately.
class="MsoNormal">Ever since the WFE witnessed the effect that OTC markets had on the financial crisis in 2008, Clifford said, the group has been working on assessing the best policies for the markets and was frustrated in that effort by the lack of "reliable data." Despite the new rules, little has been implemented. "There is still quite a free lunch in the OTC market. They're not posting the collateral -- and getting away with it," Clifford said. Exchanges, on the other hand, have had to put in risk controls not necessarily in use in the OTC markets, he said, "even though during the crisis there was no problem pricing contracts and delivering derivative trades on exchanges." ....