of the financial system

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1 The relevance of CPSS IOSCO PMFIs and OTC derivatives markets reforms for the overall stability of the financial system Sylvie Mathérat Deputy Director General Operations Banque de France 1

2 OTC Derivatives : which lessons from the crisis? The crisis underlined 4 main issues on CDS market 1. A concentrated and consanguine market 800 Concentration 5 dealers = 50 % of the trades (gross notional), DTCC, April A digital risk 'one to zero Jump to default The Lehman case 0 Jan.07 Jul.07 Jan.08 Jul.08 Jan A low transparency, which supports contagion CDS spreads contagion 4. A low collateralisation 60,0% 50,0% 40,0% 30,0% 20,0% 10,0% 0,0% 40,0% Large banks Medium banks Small banks Total (Top 10) Low collateralisation level of positive net market exposure 2

3 CCPs and TRs roles in financial stability have gained full recognition G20 Orientations, Pittsburgh, Septembre 2009: All standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end 2012 at the latest. OTC derivative contracts should be reported to trade repositories. Indeed CCPs and TRs have a central and positive positive impact on financial stability : CCPs enable netting effects and a decrease in operational risk; CCPs ensure novation and decrease counterparty risks TRs increase transparency and data access for market participants as well as for authorities Given their central role, CCPs and TRs do also concentrate risk and might create single points of failure, therefore demanding principles are needed to ensure robustness of these FMIs and to prohibit competition on risk management. 3

4 In a framework where mandatory clearing of standardized OTC derivatives is introduced, CPSS PFMIs raise the bar for CCPs (1/2) Credit Risk: All CCPs should cover the default of the biggest participant and its affiliates. Specifically, for CCPs involved in activities with a complex risk profile or systemically important in multiple utpejurisdictions, s, cover 2is required. ed Liquidity Risk: Qualifying liquid resources include cash at the CB of issue and at creditworthy commercial banks, committed lines of credit/ swaps/ repos and highly relibale funding arrangements + Incentive for a routine access to CB facilities: «If a CCP has access to routine credit at the CB of issue, the CCP may count such access as part of the minimum requirement to the extent it has collateral that is eligible for pledging to the relevant CB.» 4

5 CPSS PFMIs raise the bar for CCPs (2/2) Segregation and portability: A CCP should have rules that enable the segregation of positions and collateral of clients either via omnibus client accounts or individual client accounts. Business risk: At a minimum, a CCP should hold liquid assets equal to at least six month of current operating expenses. Procyclicality risk: To the extent practicable and prudent, a CCP should adopt forward looking and conservative margin requirements that are specifically designed to limit the need for destabilising, procyclical changes. Responsability E: Cooperation among authorities for the promotion of safety and efficiency. 5

6 In a framework where mandatory reporting of ALL derivatives is introduced, the efficiency and robustness of TRs are crucial (1/2) Operational Risk: CPSS IOSCO PFMIs require that a business continuity plan should incorporate the use of a secondary site and should be designed to ensure that critical IT systems can resume operations within 2 hours. CPSS IOSCO PFMIs evenen introduce a principle dedicated to TR regarding the disclosure of market data by TR: TR should provide data in line with regulatory and industry expectations to relevant authorities and the public in line with their respective needs. Level of detail sufficient to enhance market transparency and support other policy objectives Provision of data in a timely and appropriate manner Formats easily analysed 6

7 The efficiency and robustness of TRs are crucial (2/2) Responsability sab E: relevant ee tauthorities t should coordinate to ensure e timely access to trade data recorded in a TR CPSS IOSCO report on OTC derivatives data reporting and aggregation requirements specifies minimum requirements for reporting data, types of acceptable data, and supports the development and implementation of LEI and standard international classification system. Ongoing work: FSB ad hoc group of experts to further consider means of filling current data gaps CPSS and IOSCO joint group to examine authorities' access to trade repositories. 7

8 It is of the uttermost importance to ensure consistency of all requirements with the same overarching goal of financial stability OTC Derivatives Coordination Group: international coordination for implementation of 4 safeguards + «assessment paper» (BCBS, CGFS, CPSS, IOSCO) Fair and open direct access; Effective cross border oversight ; Effective resolution regime ; Cross border liquidity arrangements. Basel 3 and CPSS IOSCO o Capital requirements should incentivize the use of CCP The treatment of qualifying vs. Non qualifying CCPs should incentivize CCPs to be compliant with CPSS IOSCO PFMIs. Capital requirements for trades remaining bilateral should be set at a high level (current works by WGMR) o Margin requirements should incentivize standardisation and clearing Bilateral margins should be higher than margins for standardized cleared products. On going work on resolution of FMIs 8