Preparations in place for OTC transparency

ISDA's 2010 Regional Conference in London yesterday focused on, among other areas, global developments in OTC derivatives clearing. With the industry continuing to deliver on central clearing commitments, both traders and clients are preparing for the coming legislative impact on OTC trades.

In regards to both inter-dealer clearing and client clearing, LCH.Clearnet md Simon Grensted said during one conference session: "There is a common misconception that dealers will use methods to block clearing, which simply isn't true. Dealers have shown dedication and commitment to the CDS clearing service and so far have cleared 90% of eligible trades."

Central clearing legislation will come into force next summer in the US and during 2012 in Europe. Grensted went on to say: "For client clearing, both clients and dealers have to work together in order to get the best from the clearing function. In order to do this, it is critical that clients understand the risks of their trades and the impact on overall trading."

ICE Clear Europe president and coo Paul Swann commented on the functions of clearinghouses. "Clearinghouses are developed to build a pyramid to accommodate the asset classes and credit products and to provide the best services for user needs. They are also designed to ensure that there is a continuous innovation around the membership structure of each asset class," he said.

Swann went on to discuss the clearing eligibility of products, asking at what stage the OTC product becomes a risk. "Although transparency makes sense," he noted, "trying to force low liquidity into that structure doesn't always address the issue. We need a new sandbox for these to develop."

He further commented on the problematic aspects of clearinghouse risk committees, stating that products and trades will not be correctly cleared unless it is only professionals that judge the issues at hand. A lack of understanding on the central clearing process could have serious implications on how many OTC trades are cleared in the future, Swann warned.

ISDA reiterated that it fully supports increased central clearing where it reduces counterparty risk in the financial system. This calls for robust and resilient standards for clearinghouses, the association notes, and a carefully judged approach to identification of derivative contracts that are appropriate for clearing.

To date, over US$66trn in CDS have been torn up and another US$10trn of CDS trades have been cleared, according to ISDA ceo Conrad Voldstad. Considering that the current level of CDS outstanding is US$25trn, this means that the industry has worked collectively to reduce outstanding CDS volumes by nearly 75%, he added.

Based on DTCC data for CDS in the past six months, only five names - all sovereign entities - averaged 20 trades per day. Some single reference name may have multiples of 40 distinct contracts available for trading.

"These are interesting figures," Voldstad continued. "They illustrate the story of a market that has much less volume than one might imagine from the US$600trn figure we all talk about. They are much more consistent with a market where less than US$100trn is not cleared."

LB