Following on from its white paper last month, London-based consultancy Adsatis has published another report looking into the clearing counterparty (CCP) approach in comparison to bilateral agreements with regards to OTC derivatives. Adsatis consultant and author of the white paper, Bill Hodgson, reckons firms can apply aspects of the CCP approach to a non-CCP environment.
“Commentators, politicians and regulators have variously suggested hugely complex solutions to the worlds credit exposure crisis, such as a global trade registration system, clearing every single OTC product through a massive CCP, or abolishing OTC products altogether. Our contention is that the framework is already in place to handle the measurement and mitigation processes, but perhaps the market could learn from the CCP approach in how protection layers are constructed,” explains Hodgson.
The white paper, entitled “Comparing the ISDA bilateral exposure management model with a CCP”, like the title suggests, compares the way credit risk is managed using the bilateral ISDA Credit Support Annex (CSA) versus the risk management approach of a CCP. It highlights areas of difference such as membership criteria, quality of protection from credit risk and operational and timing issues.
Hodgson suggests that it may now be time for “CSA 2.0” in order to provide a more “meaningful link between risk and protection” in light of the current financial climate. Principles such as agreed data formats for publishing reconciliation data and the publication of the date on which the last valuation was calculated for a trade, both of which are used in the CCP version, could be adopted in the new version of the CSA, suggests the paper.
Although many OTC products will never be suitable for a CCP, this does not mean CCP principles cannot be applied to the area, Hodgson suggests. He concludes: “Isn’t it time to blend the experience of both markets and upgrade the financial technology to give firms a higher level of protection and a positive feedback loop to associate higher margin levels with illiquid products and to balance banks enthusiasm for such risky trading?”