10 October 2012

OTC Derivative Regulations and Sovereign Debt

Unintended Consequences

Sibos 2012 in Osaka will see the debut of the Sibos Colloquium, an exploration of the contrasting views of academia and industry regarding the regulations of OTC Derivative clearing.

Hosted by the SWIFT Institute, topical presentations by each speaker will be followed by an exclusive opportunity for delegates to participate in open debate. Our previous articles have examined the effects of the forthcoming regulations on market infrastructure and whether the introduction of a tax on residual derivative liabilities would prevent a taxpayer bailout of central counterparties (CCPs).  This final article in our series of four will examine the possible unintended consequences of regulations, namely the potential deterioration of a sovereign debt crisis.

Godfried De Vidts, Director of European Affairs at ICAP plc is concerned by the risk of any CCP defaulting as this would have a profound impact on a sovereign’s debt.  Mr. De Vidts comments, “The downgrading over the past few years of sovereign debt has been due to the bailing out of banks, impacting negatively on the rating of sovereigns and CDS prices in turn.  The same principles would apply in the event of a CCP default.”

On the other hand, Manmohan Singh, Senior Economist at the International Monetary Fund, is more concerned that regulators discussing the role of the CCP are not considering the potential effect of other synergies.  In his article “The fallacy of moving the over-the-counter derivatives market to central counterparties“, Mr. Singh outlines his fears that under-collateralisation by large banks leads to hedging derivative receivables, which ultimately increases a sovereign’s credit default swap and in turn inflates a sovereign’s debt issuance cost.  He recommends the introduction of a derivative liability tax in order to address the problem of under-collateralisation by sovereigns (which are currently exempted from the regulations).

The audience will have the unique chance to consider the divergent perspectives in this previously unexplored subject, not only from the standpoints of our experts, but from the floor in what is anticipated to be a thorough and animated debate.

The Sibos Colloquium will take place on Monday 29 October, 11:00 – 12:00; Conference Room 2, INTEX Centre, Osaka, Japan.

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