The deputy secretary general of the world's regulated exchanges, the World Federation of Exchanges, wants to be sure the group's intentions are understood. The WFE isn't out to dispense with OTC markets, Peter Clifford told Institutional Investor, it just wants to reduce the systemic risk that exists today.
The first step in reducing that risk was getting independent research to put a number on it. Late last year the Tabb Group estimated OTC derivative risk exposure at $700 trillion with a shortfall in collateral of $2.2 trillion. Now the WFE is considering its second step.
Clifford has made no bones about having been surprised, as were senior Tabb Group analyst E Paul Rowady and an unaffiliated researcher with the IMF engaged in his own study, Manmohan Singh, by the staggering size of the collateral shortage. Off the record, OTC market participants see the WFE as on a mission to gather converts to exchange-based trading. To their point, the WFE publicly supports the reform regulations aimed at the OTC derivatives markets, which it says contributed to the recent financial crisis.
But Clifford insists, "The WFE wants to make it clear that the OTC markets are a natural complimentary force to the business that happens on an exchange. The situation we're in now is that governments and regulators are saying there has to be less systemic risk." And, he adds, "when we look at the work on exchanges, we've handled that by transparency and post-trade arrangements that held up throughout the crisis. So the question is how can we organize these markets so they'll remain vibrant, effective but have less risk involved in the future."
The 52-member WFE, based in Paris, celebrates its 50th anniversary this year, with pledges to also support cooperation and coordination among regulators and exchanges on intermarket mechanisms, and to examine the structure of fixed income markets. William J Brodsky, of the Chicago Board Options Exchange, the first chair of a derivatives exchange to head the WFE, is replaced this year by Ronald Arculli, chairman of the Hong Kong Exchanges and Clearing (HKEx). Although Clifford expects, as all chairmen, Arculli to have his own emphasis, the work on risk reduction will continue.
While declining to address the WFE by name, a spokesman for the International Swaps and Derivatives Association, provided this statement: "ISDA and the OTC derivatives industry are very focused on reducing counterparty risk, as evidenced by the fact that the industry has cleared 50 percent of the interest rate swaps market and $15 trillion of the CDS market. In addition, portfolio compression has reduced outstanding notionals by $100 trillion in IRS. The combination of central clearing and portfolio compression have reduced the size of the credit default swaps market by 75 percent. The volume of cleared swaps could double in the next two to three years." He said the periods referenced are "in present time."
According to news reports, Edward Rosen, a lobbyist with the law firm of Cleary Gottlieb Steen & Hamilton LLP, has gone to work on mitigating the OTC reforms, at the behest of ISDA. They also say nine other banks have hired Rosen to similarly lobby Congress on their behalf.