Major Banks Commit To Expand Use Of Central Clearing For OTC Derivatives

by Glen Shapiro, LawAndTax-News.com, New York

11 September 2009

The Federal Reserve Bank of New York has received commitments from 15 major over the counter (OTC) derivatives dealers setting specific target levels for expanding central clearing of OTC credit and interest rate derivatives.

Using central counterparties, that absorb losses when a contracting party defaults, should serve to prevent a repeat of the market ructions when major counterparties such as AIG and Lehman Brothers defaulted. The dealers, consisting of the major commercial banks of the USA and Europe, believe that their actions will significantly reduce the systemic risk profile of the OTC derivatives market.

The letter sets out the following targets for submitting new trades to central counterparties (CCPs) and for clearing historical trades. These targets will be increased over time as dealers improve their capacity to clear trades. In addition, the major dealers are agreeing today to report a broader set of data that will allow regulators to monitor CCP usage better.

For Interest Rate Derivatives:

• 90% of new eligible trades (calculated on a notional basis) will be cleared from December 2009.
• 70% of new eligible trades (calculated on a weighted average notional basis) will be cleared from December 2009.
• 60% of historical eligible trades (calculated on a weighted average notional basis) will be cleared from December 2009.

For Credit Default Swaps:

• 95% of new eligible trades (calculated on a notional basis) will be submitted for clearing from October 2009.
• 80% of all eligible trades (calculated on a weighted average notional basis) will be cleared from October 2009.

The dealers have also agreed to work with the clearing houses and regulators globally to broaden the set of derivative products eligible for clearing, taking into account risk, liquidity, default management and other processes.

"Over the last year, regulators have worked to increase OTC derivatives clearing in order to enhance the resilience of the financial system. These targets will push major dealers to accelerate their progress. We also expect them to work with central counterparties to expand the universe of eligible products and to continue to increase clearing levels beyond these initial targets," said New York Fed President William C. Dudley.

These commitments follow a June 2, 2009, letter from market participants to regulators in which market participants outlined a series of steps to expand the use of CCPs for OTC derivatives. Concurrent efforts include extending the risk reduction benefits of central clearing to buy-side market participants and expanding central clearing to cover a wider range of products.

Supervisors expect market participants to set increasingly stringent targets over time and to meet the December 15, 2009, customer clearing commitment set in the June letter. The New York Fed will continue to work with other domestic and international banking supervisors to monitor market progress on these objectives.

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