26 September 2012

Tax or Taxpayer Bailout?

Will OTC Derivative clearing regulations create CCP’s too-big-to-fail?

The newly created Sibos Colloquium at Sibos in Osaka will focus on the debate surrounding the forthcoming OTC Derivatives clearing regulations. Hosted by the SWIFT Institute on 29 October 2012, the Colloquium will present the views of academia, represented by Manmohan Singh, Senior Economist at the International Monetary Fund, and industry, represented by Godfried De Vidts, Director of European Affairs at ICAP plc. Our previous article examined the potential impact of the forthcoming regulations on market infrastructure, and this third in a series of four articles will explore the effect on the taxpayer in whose name the regulations are intended to protect.

Manmohan Singh is adamant that only an additional tax on large banks can adequately protect the taxpayer from having to bailout institutions deemed “too-big-to-fail”.  His paper “Making OTC Derivatives Safe – A Fresh Look” outlines the original intentions of the regulators by mandating that OTC derivatives are to be cleared by central counterparties (CCPs), but argues that in reality a transfer of risk to outside the banking system will occur.  A CCP, he reasons, may need central bank support should it suffer a series of member defaults and become subject to a run resulting from credit concerns.  Mr. Singh explains, “The regulatory proposals may not remove systemic risk from OTC derivatives, but rather shift it from banks to central counterparties, whilst the taxpayer remains on the hook”.   Mr. Singh concludes, “a tax on the derivative liabilities (after all possible netting) of large banks would address the source of the under-collateralisation problem, and make the OTC derivatives market safer.  This in turn would mean that many of the exemptions given to privileged users under the proposed regulations (sovereigns, central banks, multilaterals, pension funds etc.) would need to be recalled.”

Will layering on more legislation, levies and red tape bring us any closer to solving the problem? Godfried De Vidts, Director of European Affairs at ICAP plc, argues that the imminent regulations do go far enough.  He points out, “G20 leaders have mentioned that the taxpayer will no longer be up for future bailouts. The mutualisation of risk within a CCP, together with “skin in the game” from the CCPs, and the 2% capital charges for centralised clearing should be enough to avoid any taxpayer bailout.”

In Osaka, not only will you have the opportunity to hear the opposing arguments, but also the opportunity to put your questions to the speakers.  The SWIFT Colloquium will take place on Monday 29 October, 11:00 – 12:00; Conference Room 2, INTEX Centre, Osaka, Japan.  The next and final article in the series will review the unintended consequences of regulatory exemptions with regards to derivatives clearing and CCPs’ on sovereign debt.


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