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BIS releases report on derivatives reform
28 August 2013
Net benefit to global economy of OTC reforms
Bank of International Settlements
The Bank of International Settlements' (BIS') Macroeconomic Assessment Group on Derivatives (MAGD) has reported on the macroeconomic effects of OTC derivatives regulatory reform.
The report states that uncollateralised counterparty exposures on OTC derivatives “helped propagate and amplify” the global financial crisis, resulting in reforms to reduce counterparty risk in the OTC derivatives market.
It notes: “While these reforms have clear benefits, they do entail costs. Requiring OTC derivatives users to hold more high-quality, low-yielding assets as collateral lowers their income. Similarly, holding more capital means switching from lower-cost debt to higher-cost equity financing.
"Although these balance sheet changes reduce risk to debt and equity investors, risk-adjusted returns may still fall.
"As a consequence, institutions may pass on higher costs to the broader economy in the form of increased prices.”
The report focuses on the effects of policy measures designed to reduce counterparty risks within the OTC derivatives market - central clearing of standardised OTC derivatives, margin requirements for non-centrally cleared OTC derivatives and bank capital requirements for derivatives-related exposures.
It presents a quantitative assessment of the macroeconomic implications of over-the-counter (OTC) derivatives regulatory reforms, using models to estimate the costs and benefits and costs the proposed reforms.
The report found that the main benefit of the reforms would be a reduction in lost economic output as a result of fewer of financial crises through OTC derivatives exposures, while admitting there would be a reduction in economic activity from the higher prices of risk transfer and other financial services.
It developed three scenarios – higher and lower costs, and a 'preferred' middle course. Under the preferred outcome, it found benefits worth 0.16% of GDP per year and costs of 0.04% of GDP per year, resulting in net benefits of 0.12% of GDP per year. In the low-costs scenario, net economic benefits would be 0.13%, while under the high-costs scenario, this would fall to 0.09%.
“These are estimates of the long-run consequences of the reforms, which are expected to apply once they have been fully implemented and had their full economic effects,” it noted.
In order to maximise the net benefit of the reforms, the Group called on regulators and market participants to “make as many OTC derivatives as possible safely centrally clearable” and ensure there is a “modest number” of central counterparties or make central counterparties interoperable.
“This should include efforts to harmonise the rules governing cross-border transactions, so that market participants have equal access to CCPs,” it recommended.
The report can be read in full here