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The future for otc derivatives


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Presentation to CPBI Atlantic March 2012

Published in: Economy & Finance, Business
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The future for otc derivatives

  1. 1. Stephen Thompson CFAManager of Derivatives and Quantitative EvaluationProvince of Nova ScotiaLiability Management and Treasury Services
  2. 2. Occupational Hazard
  3. 3.  Allied Irish Bank ($700 million) Amaranth ($6 billion) Barings ($1 billion) Daiwa ($1 billion) Enron Counterparties (Several over $1 billion) Kidder Peabody ($350 million) LTCM ($4 billion) Midland Bank ($500 million) Société Générale ($7 billion) Subprime Mortgages & Lehman (up to $40 billion)
  4. 4. “The derivatives genie is now well out of the bottle, andthese instruments will almost certainly multiply in varietyand number until some event makes their toxicity clear.Central banks and governments have so far found noeffective way to control, or even monitor, the risks posed bythese contracts. In my view, derivatives are financialweapons of mass destruction, carrying dangers that, whilenow latent, are potentially lethal.” Warren Buffett 2002
  5. 5.  All standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, And cleared through central counterparties by end-2012 at the latest. OTC derivative contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements.
  6. 6.  Increase transparency Improve market efficiency Reduce systemic risk
  7. 7.  No Reforms for Exchange Traded Derivatives Over the Counter trades seem the sole focus of International Scrutiny Push is to limit, or eliminate Bilateral Trading
  8. 8.  Any discussion about OTC derivatives is now necessarily a discussion about Legislation and Regulations Driven by;  Optics, we must be seen doing something  Politics, both global and domestic (be ahead of the US or be subject to their rules)
  9. 9.  Federal Reserve Act of 1913: 32 pages Glass-Steagall act: 37 pages Sarbanes Oxley: 66 pages Dodd-Frank: 848 pages  Franken Dodd, Dodd Frankenstein…
  10. 10.  Canadas G20 commitment of clearing over-the- counter (OTC) derivatives by December 31st, 2012  Canada is moving faster than most to enact both G20 commitments and Basel III Requirements. Canadian OTC Working Group Recommendations provide clues to framework.  Look for Canadian CCP’s, SDR proposals  No National Securities Regulator but Expanded Federal Roles in Derivatives Markets
  12. 12.  CFTC (or SEC), CCP and SEF determine which swaps must trade exclusively on a Swap Execution Facility (“SEF”) Must be executed on a SEF if;  transaction falls with the “swap” definition in the Act; and  the swap type is mandated by the CFTC (or SEC) to be cleared on a CCP; and  the client is not exempt from the requirement to clear Block trades: CFTC vs SEC rules Block trade definition
  13. 13.  Clearing and electronic trading will be mandated for many products and users Multilateral trading most likely prominent Increased capital charges for uncleared trades and possibly minimum margin requirements Liquidity will be affected by the changes in style of trading, margin requirements, reporting requirements, costs Collateral requirements will increase for most whether cleared or not Counterparty risks may be reduced
  14. 14.  Asset-Liability matching Asset Allocation  Diversification  Leverage LDI Strategies Alternative Investments Innovation and Risk Management
  15. 15.  Prepare for new cost structures  Increased Capital Costs for Non-cleared trades  Increased transaction costs for cleared trades Prepare for Collateral Management either in-house or through intermediaries Prepare for increased legal costs  ISDA / CSA Prepare for increased transaction Reporting and associated costs
  16. 16.  Look back to cash market mandates  Is cash more effective than swaps + Collateral? Sit down with Managers whose mandates have derivative heavy strategies.  Strategies should already be in place  Operational costs may become a pressure
  17. 17.  Will increased complexity push Buy-side investors from bilateral markets? ▪ Maybe, but these are the testing ground for innovation Is this the end for the OTC Market? ▪ Remains to be seen. Likely be a smaller club with more agency relationships. Bilateral trading will become highly scrutinized Does any of this satisfy the G20 goals? ▪ Not on its own but stay tuned