The Present Value

ISDA highlights a selection of research papers on derivatives and risk management


OTC Premia

Bank of England Staff Working Paper No. 751
By Gino Cenedese, Angelo Ranaldo and Michalis Vasios

This paper examines the effect of the new regulations on the pricing of over-the-counter (OTC) derivatives. Using Depository Trust & Clearing Corporation data, the authors conduct pricing analysis of interest rate swaps (IRS) and find substantial price differentials, which they call OTC premia. The report provides several reasons for OTC premia, including whether the transaction is cleared via a central counterparty (CCP) or cleared bilaterally, whether initial margin is posted and counterparty credit risk. Clients pay more for non-CCP transactions, but the premium substantially decreases when initial margin is posted or when a client has a higher credit rating. The authors explain that in the new regulatory framework, dealers require compensation for holding derivatives positions, which entail regulatory costs, and they pass these costs to other market participants via market prices.

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How EMIR Data Helped Regulators Better Understand the Impact of Policies

Financial Conduct Authority
By Anne-Laure Condat, Alessandro Puce and Carsten Nommels

The paper evaluates the impact of clearing and initial margin requirements introduced by the European Market Infrastructure Regulation (EMIR). Using a sample of UK reporting financial counterparties’ outstanding OTC derivatives trades, the study shows the effect of various thresholds on the markets. The authors demonstrate that the UK OTC derivatives market is characterized by a high level of concentration and a small number of large financial counterparties that account for the vast majority of market activity. The study suggests that giving small financial firms an exemption from clearing could significantly reduce the burden on them, without compromising EMIR’s policy objections. The study also points out that the phase-in of initial margin requirements does not result in the intended gradual increase in the number of counterparties subject to the requirements, and there is a sharp increase in the very last phase-in in September 2020.

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Credit Market Choice

Federal Reserve Bank of New York Staff Report No. 863
By Nina Boyarchenko, Anna M. Costello and Or Shachar

The paper analyzes the choice between corporate bond and credit default swap (CDS) markets made by large financial institutions when they need to change their exposure to credit risk. The study finds that large financial institutions have a low probability of changing their exposure to any particular reference entity in an average week. When they do change their exposure, they are more likely to use the CDS market. Simultaneous transactions in both markets are rare. The paper demonstrates that financial institutions changed their strategies in response to variations in the regulatory environment, reducing their use of the CDS market overall. US global systemically important banks (G-SIBs) increase the volume and frequency of their transactions in single-name CDS after the single-name contract becomes eligible for clearing. This finding suggests that regulatory capital constraints play an important role in the choice of the market.

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