Post-trade risk reduction has become increasingly common as a means to reduce risks in the derivatives market. Portfolio compression is a case in point: offsetting trades between multiple parties are torn up, which reduces the size of gross exposures, in turn reducing systemic risk. Over €1,000 trillion in derivatives exposures has been eliminated in this manner.
Regulators recognize the value of compression. Under the European Market Infrastructure Regulation (EMIR), market participants with more than 500 over-the-counter (OTC) trades on their books are required to examine the possibility of performing portfolio compression twice a year.
However, EMIR simultaneously disincentivizes use of this service by requiring administrative trades that result from compression, and which fall under the clearing mandate, to be cleared. This limits the ability of participants to perform compression and reduce risk.
The same is true of other post-trade risk reduction services like counterparty rebalancing. This involves inserting new, market-risk neutral transactions into netting sets to reduce risk exposures between counterparties. This decreases counterparty credit risk and therefore reduces systemic risk. However, those new transactions are required to be cleared if they are subject to the clearing obligation, preventing counterparty rebalancing risk reduction from taking place. As a result, counterparty rebalancing today is only limited to FX derivatives, which are not subject to the clearing obligation. Over €100 billion in counterparty credit risk has been reduced in this manner.
ISDA, the EBF, ICMA and ISLA believe EMIR should be amended as part of the Regulatory Fitness and Performance program (REFIT) to allow non-price forming, market-risk neutral transactions that result from post-trade risk reduction services to be exempted from the clearing obligation.
To read the full whitepaper, click on the link below.
Documents (1) for Incentivizing Post-trade Risk Reduction
Latest
ISDA AGM Studio: Sid Nadella, Google Cloud
Sid Nadella, director and global head of capital markets solutions at Google Cloud, speaks to Joel Clark, ISDA’s senior director of communications, on the extent artificial intelligence is being used by financial institutions and the biggest risks and challenges of...
Celebrating ISDA’s Successes and the Next Decade
Today, May 23, marks exactly 40 years since ISDA, initially known as the International Swap Dealers Association, was first established by a small group of mostly New-York-based dealers. At ISDA’s Annual General Meeting (AGM) in Amsterdam last week, we had...
ISDA Response to CFTC on 24/7 Trading
On May 21, ISDA, the Securities Industry and Financial Markets Association (SIFMA) and its asset management group (SIFMA AMG) submitted a joint response to the US Commodity Futures Trading Commission’s (CFTC) request for comment on 24/7 trading and clearing. The...
ISDA AGM Studio: Jack Hattem and Jared Noering
Jack Hattem, ISDA board member and managing director, global fixed income at BlackRock, and Jared Noering, ISDA board member and global head of fixed income trading at NatWest Markets, talk to Nick Sawyer, ISDA’s global head of communications, on how...