Centrally Cleared Derivatives:
Mitigating Counterparty Risk for Institutional Investors
“You’ve gotvirtually nocounterparty creditrisk in the futuresmarkets[standardised contracts]... and another
factor isthere isasmaller pool of dealersnowfor OTCtrades... . There islikely tobe aflighttosafety.”
Susan Ervin former Chief Counsel, CFTC, Division of Trading and Markets.
Some Talk Up Flight To Exchange-Traded from OTC, DerivativesWeek, October 2008.
“In the longer term, there’snodoubtin my mind thatin 2009 or 2010, you’re going tosee amigration to
exchange traded fromOTC, or atthe very least, centrally cleared OTCproducts.”
Simon Yates, Head of Global Equity Derivativesand Co-Head of Global SecuritiesEMEA, CreditSuisse.
Rocked by Counterparty Risk, RISK, November 2008.
By Eurex Clearing
H
istorically, derivatives have always been regarded as the counterparty to all trades, enforces a strict risk control
falling into one of two subsets; exchange traded andanadequatecollateralisationofopenpositions.
derivatives (ETD), standardised contracts designed by
•
Margin Offset – The transfer of OTC derivative
and traded on a listed exchange, and over-the-counter transactions into Eurex’s clearing system has the benefit of
derivatives(OTC)eitherhighlystandardised‘exchangelook-a- margin offset with existing open Eurex exchange-listed
like’ contracts or customised derivative contracts traded derivative positions.
between twoindividual counterparties.
•
Attain Competitive Pricing – Institutional investors are
The recent turmoil in financial markets, with bank defaults able to conclude their bilaterally agreed OTC transactions
and bailouts, has rightly focused attention on counterparty onapurelypricebaseddecisionknowingthatcounterparty
risk and brought into prominence and importance a new risk isnotaconsideration.
1
subset in derivatives; Centrally Cleared Derivatives (CCD),
•
Reduction of Capital Requirement – Increased capital
derivative transactions traded bilaterally and brought on efficiency through a zero percent weighting of exposure
exchange to benefit from the clearinghouse that is Central basedonPillarIIofBaselIIwhichrecognisesthedistinction
Counterparty (CCP) and thereby mitigating counterparty risk. between bilateral OTC transactions and OTC transactions
cleared through aCCP.
2
Benefits of Centrally Cleared Derivatives
•
Independent Daily Mark-To-Market Valuation – Eurex
The novation of bilaterally agreed derivatives transactions Clearing produces a daily valuation of all open positions
entered into a central counterparty like Eurex Clearing has leading to superior risk management and greater
significantbenefitsfor the institutional investor: transparency.
•
MitigationofCounterpartyRisk–EurexClearingbecomes
•
Multilateral Netting – Makes OTC contracts fungible
between different counterparties so they
Figure 1: OTC Derivatives: Counterparty Risk & Threat of Contagion
can be netted off against each other –
increases the flexibility and ability to
enter and exitan OTCposition.
•
Processing Efficiency
3
– Reduces
manual errors through full automation
and straight-through-processing (STP) as
well as an efficient use and management
of collateral.
Figures 1 & 2 outline the differences
between counterparty risk in over-the-
counter and exchange-traded/exchange-
cleared derivatives and the role of the
clearinghouse. Bilateral OTC derivatives
have an explicit counterparty risk
between the two counterparties in the
Source: Eurex Clearing. OTC Derivatives: The default of firm A in an OTC derivative
bilateral transaction. Moreover, in the
transaction has a possible contagion effect. It does not only affect firm F, it leaves all
connected trading counterpartiesfromfirmAtoF potentially atrisk.
event of a default in a bilateral OTC
transaction, there is a risk of contagion
38 worldPower2009
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