New developments in clearing and settlement arrangements for OTC derivatives

The Committee on Payment and Settlement Systems (CPSS) is today issuing a report on New developments in clearing and settlement arrangements for OTC derivatives. The report analyses existing arrangements and risk management practices in the broader OTC derivatives market and evaluates the potential for risks to be mitigated by greater use of, and enhancements to, market infrastructure.

The report focuses on the risks created by delays in documenting and confirming transactions; the implications of the rapidly expanding use of collateral to mitigate counterparty credit risks; the potential for expanding the use of central ounterparty (CCP) clearing to reduce counterparty risks; the implications of OTC derivatives prime brokerage; the risks associated with unauthorised novations of contracts; and the potential for significant market disruptions from the closeout of OTC derivatives transactions following the default of a large market participant.

The report concludes that, over the past few years, the clearing and settlement infrastructure of OTC derivatives markets has been significantly strengthened. But further progress is needed in some areas:

• institutions need to extend the successful efforts to reduce confirmation backlogs in credit derivatives to other OTC derivative products, using automated systems whenever possible. To mitigate the risks of remaining backlogs, more systematic use of economic affirmations is appropriate and over time dealers should work toward daily portfolio reconciliations with their most active counterparties;
• market participants should identify steps to mitigate the potential market impact of replacing contracts following the closeout of one or more major participants.

In addition, as the market infrastructure moves further in the direction of centralised processing of trades and post-trade events, several issues will assume greater importance:

• providers of essential post-trade services for OTC derivatives should provide open access to their services and should aim to achieve convenient and efficient connectivity with other systems;
• central banks and supervisors will need to consider whether certain existing standards for securities settlement systems, CCPs or systemically important payment systems should be applied to providers of clearing and settlement services for OTC derivatives that are not already subject to those standards.

Interested parties are welcome to send comments on the report to the CPSS Secretariat (cpss@bis.org); please mention OTC derivatives in the subject line of your email. Comments will be made available on the website of the BIS.

Notes to editors

The report has been prepared for the CPSS by a working group consisting of representatives of prudential supervisors of major derivatives dealers as well as representatives of the central banks that are CPSS members. The Basel Committee on Banking Supervision had an observer on the group. The working group was chaired by Patrick Parkinson of the Board of Governors of the Federal Reserve System.

The CPSS serves as a forum for central banks to monitor and analyse developments in payment and settlement arrangements and to consider related policy issues. The chairman of the CPSS is Timothy F Geithner, President and Chief Executive Officer of the Federal Reserve Bank of New York. The CPSS secretariat is hosted by the BIS. More information about the CPSS, and all its publications, can be found on the BIS website (http://www.bis.org/cpss/index.htm).