It’s likely that securities firms are justifiably ambivalent about the execution and clearing reforms coming for over-the-counter (OTC) derivatives. Yet a recent survey conducted by consultancy Rule Financial and Calypso Technology provides evidence that firms are making changes despite doubts about the reforms and their ability to reduce systemic risk. Half of the survey respondents said that the clearing reforms for OTC trading would not reduce systemic risk. However, nearly half of those surveyed, or 44%, said that regulatory and market changes such as the Dodd-Frank Act and the European Market Infrastructure Regulation (EMIR) initiatives will cut systemic risk; 6% said they were uncertain of the regulatory impacts. Overall, 74% of respondents say the new rules will increase transparency in the OTC markets.
The survey results from Rule and Calypso are based on the data gathered from 34 respondents polled on Nov. 15 at the debate, “Collateral optimization: Are We Nearly There Yet?” held at the University College of London (UCL). The attendees included executives and managers from investment banks, custodians and asset managers working in IT, operations, risk and collateral management units.
The survey also found that 79% of respondents said they know they need collateral optimization while only 12% report they have it. One quarter, or 26%, say they will achieve optimization within 9 months; 24% within 12 months; and 32% say they do not know when they will achieve optimization. Slightly more than a third, 38% are still undecided about the software they will use to optimize their collateral; 26% will use custom-built systems; and 9% will install packaged software.
The survey revealed a consensus that the preferred hierarchy for collateral optimization has interest rate derivatives in first place, equity derivatives in second, and credit default swaps in third. Structured products and FX derivatives follow somewhere behind.
There’s another consensus, according to David Field, executive director of Rule Financial, who in a prepared statement pointed to “the need to have an enterprise-wide view of collateral to ensure regulatory compliance and match collateral availability to obligations triggered by centralized clearing.” Field added that a “magic circle” of top banks is spending “between £25 to £30 million ($39.3 million to $47.1 million) a year on collateral management infrastructure” to get this enterprise-wide view and thus optimization. Field said they are leading the way. “The losers will be those left behind, still pondering,” he said.
While it’s a major mistake for any firm to dither as the industry grinds ahead, we should also acknowledge that all firms great and small have every right to question the way politicians and the regulators orchestrated the reforms for the financial services industry. We should also acknowledge that firms are getting the job done as best they can given that many of the finer details of the OTC regulatory overhaul are in limbo in the US and Europe.
In addition, in the US, it’s painfully clear now that one big overhaul that was bound to miss its deadlines was a major tactical mistake. The reforms should have been carried out in a more discrete fashion—essentially slaying one dragon at a time. The US regulators should have also better coordinated their reform efforts rather than the current confusion between the SEC and CFTC over OTC clearing and execution, for instance. The US regulators should have also worked much more closely with international regulatory agencies; the last time I looked, the financial services industry is global and rather tightly connected. Finally, the regulators, at least in the US, should have set some clear priorities starting with OTC instruments and then the next most urgent matter, following the chain of destruction that led to the Great Recession and our current malaise. Doing it all at once is absurd and impossible.
Even so, firms across the globe will adjust to the OTC reforms despite the clumsiness of clueless regulators, bureaucrats and politicians. But we now see two key limitations of the regulators—their ambitions were far greater than their resources, and they were ill-suited to be the reformers that we needed.
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