The Financial Stability Board (FSB) and the other standard-setting bodies (SSBs) (i.e. the Basel Committee on Banking Supervision, the Committee on Payments and Market Infrastructures, the Financial Stability Board and the International Organization of Securities Commissions) reconvened the Derivatives Assessment Team (DAT) to “re-examine whether adequate incentives to clear centrally over-the-counter (OTC) derivatives are in place” as one of the first evaluations under the FSB framework for the post-implementation evaluation of the effects of the G20 financial regulatory reforms. The data collected and the analysis conducted by the DAT suggest the following findings:
- The changes observed in OTC derivatives markets are consistent with the G20 Leaders’ objective of promoting central clearing as part of mitigating systemic risk and making derivatives markets safer.
Data from trade repositories and other regulatory reporting shows that central clearing has increased markedly for many types of derivatives, notably interest rate and credit derivatives. Increased clearing is found both for products subject to mandatory clearing and for some that are centrally cleared on a voluntary basis. For example, clearing levels (as measured by notional amounts outstanding) increased from 24% (in 2009) to 62% (in 2017) for interest rate derivatives. Increased clearing levels are found among the large dealing banks and, more recently, among clients.
- The relevant post-crisis reforms, in particular the capital, margin and clearing reforms, taken together, appear to create an overall incentive, at least for dealers and larger and more active clients, to centrally clear OTC derivatives.
Mandatory clearing requirements have led to increased central clearing. The preferential capital treatment of centrally cleared derivatives is considered an important incentive for dealer banks. Analysis of quantitative survey results suggests that the incentive to centrally clear OTC derivatives is also strong where standards requiring the exchange of initial margin for uncleared derivatives trades are in effect. This finding generally holds across a range of product types in different asset classes, but it is not universal. It is supported by regulatory data showing a marked increase in clearing volumes for some non-mandated OTC derivatives around the implementation dates of the margin requirements for uncleared derivatives.
- Non-regulatory factors are also important and can interact with regulatory factors to affect incentives to centrally clear.
Surveys and market outreach show that market participants, especially larger firms, consider that factors such as market liquidity, counterparty credit risk management and netting efficiencies are also important factors for incentives to centrally clear. Regulation can interact with such factors to affect incentives. For example, clearing mandates may shift liquidity into central clearing. Once liquidity is established, market participants may also wish to clear non-mandated products, perhaps to benefit from netting opportunities or a lower capital requirement. On the other hand, the relatively higher fixed costs of accessing central clearing can have a material impact on incentives too, especially for smaller, lower activity firms.3
- Some categories of clients have less strong incentives to use central clearing, and may have a lower degree of access to central clearing.
Mandatory clearing requirements have contributed to an increase in the total number of clients clearing derivatives and increases in the notional cleared by clients overall. However, while there are challenges in identifying effects on small and less active clients in regulatory data, survey responses and information from market outreach suggest that the incentives for them are mixed. Some clients reported a preference not to centrally clear when not required to do so by a clearing mandate.
There are several factors that may be contributing to this. The benefits of central clearing, such as netting opportunities and deeper liquidity pools, may be lower for smaller clients or for those with more directional positions. Survey responses state that providing connectivity to CCPs requires incurring high fixed costs, which are likely passed on to clients through minimum fees and other charges, increasing clients’ costs of central clearing. For smaller, lower activity clients in particular, this can raise their cost of cleared trades, and thus can have a material impact on their incentives to centrally clear.
Some smaller clients and some of those with more directional portfolios report experiencing difficulties gaining and/or maintaining access to central clearing. These access issues in turn impact the incentives for these clients to centrally clear.
- The provision of client clearing services is concentrated in a relatively small number of bank-affiliated clearing firms.
The majority of OTC derivatives market participants are not direct clearing members of CCPs, but rather access central clearing as clients through clearing service providers. Therefore, access to client clearing is a key structural feature of the post- reform derivatives markets.
The provision of client clearing for OTC derivatives remains generally concentrated. For example, five firms, all bank-affiliated, account for over 80% of total client margin for cleared interest rate swaps in the United States, United Kingdom and Japan. Regulatory data illustrates that, although the overall amount of client margin posted at CCPs has increased substantially since the implementation of reforms, the number of clearing service providers has stayed broadly flat over the same period.
Survey responses and market outreach are also consistent with a view that concentration in clearing service provision could amplify the consequences of the failure or withdrawal of a major provider. In particular, concerns have been expressed about the ability to port client positions and collateral in this situation. This could impact clients’ incentives to centrally clear.
- Some aspects of regulatory reform may not incentivise provision of client clearing services.
Survey data, research and market outreach suggests that some regulations aimed at improving institutional resilience may in some circumstances be discouraging individual firms from providing client clearing services; see below for further discussion. This may in turn affect access challenges for clients and the concentration of client clearing service provision.