Collateral and the OTC Derivatives Market

This chapter provides an overview of the over-the-counter (OTC) derivatives market and the associated drawbacks in the regulatory initiatives that propose to move these contracts to central counter-parties (CCPs). As cross-border issues continue to unfold, this chapter proposes an alternative that would make this market safe with relatively little by way of additional collateral costs. Furthermore, it is argued that there may not be need for creating more too-big-to-fail institutions.

Introduction

As part of the extensive regulatory reform proposals, the new rules will warrant a significant increase in the use of collateral across the financial system. Estimates by markets and research and policy institutions suggest that the DoddFrank Act, Basel III and European Market Infrastructure Regulation (EMIR) may warrant US24 trillion in additional unencumbered collateral that will span margins for OTC derivatives at CCPs; liquidity ratio(s) under Basel III; and related needs stemming from parallel developments under the EMIR and Solvency II. At the same time, due to the global financial crisis and efforts at quantitative easing (QE) in the US and Europe, significant amounts of