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Article

Ekaterina E. Emm and Ufuk Ince

The purpose of this paper is to examine the extent of systemic risk and competition in over‐the‐counter (OTC) derivatives dealing. Using derivatives‐related failures…

Abstract

Purpose

The purpose of this paper is to examine the extent of systemic risk and competition in over‐the‐counter (OTC) derivatives dealing. Using derivatives‐related failures during the 1990s, the authors draw conclusions that are pertinent to the recent financial market turmoil involving OTC derivatives.

Design/methodology/approach

The authors use the event‐study methodology with crude dependence adjustment to examine the wealth effect for the involved derivatives dealers. The authors re‐estimate the parameters using the market‐adjusted model to check for robustness. In addition, a multivariable regression framework was used to estimate the determinants of the abnormal returns.

Findings

OTC derivatives dealers experience negative returns when their clients announce derivatives losses. In contrast, rival dealers uninvolved in the loss event exhibit positive returns. The extent of the positive returns for the rival dealers grows as new events unfold, and the dealers continue to steer clear of derivatives trouble. A broader industry portfolio of securities brokers, dealers, and advisors is affected negatively, indicating possible industry contagion. The cross‐sectional analysis of the abnormal returns indicates the presence of information (and not pure) contagion implying that in a financial crisis involving derivatives systemic failure is not likely.

Originality/value

The authors extend the literature by examining an exhaustive set of derivatives loss events. The sample includes a more diverse set of derivatives dealers and it spans a longer time period than prior studies did. This is also the first study confirming the distorting impact of the “too big to fail” and “federal safety net” phenomena in the context of OTC derivatives dealing.

Details

Managerial Finance, vol. 37 no. 12
Type: Research Article
ISSN: 0307-4358

Keywords

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Article

Randall E. Duran and Paul Griffin

This paper aims to examine the risks associated with smart contracts, a disruptive financial technology (FinTech) innovation, and assesses how in the future they could…

Abstract

Purpose

This paper aims to examine the risks associated with smart contracts, a disruptive financial technology (FinTech) innovation, and assesses how in the future they could threaten the integrity of the global financial system.

Design/methodology/approach

A qualitative approach is used to identify risk factors related to the use of new financial innovations, by examining how over-the-counter (OTC) derivatives contributed to the Global Financial Crisis (GFC) which occurred during 2007 and 2008. Based on this analysis, the potential for similar concerns with smart contracts are evaluated, drawing on the failure of The DAO on the Ethereum blockchain, which involved the loss of over $60m of digital currency.

Findings

Extensive use of bilateral agreements, complexity and lack of standardization, lack of transparency, misuse and speed of contagion were factors that contributed to the GFC that could also become material concerns for smart contract technology as its adoption grows. These concerns, combined with other contextual factors, such as the risk of defects in smart contracts and cyberattacks, could lead to potential destabilization of the broader financial system.

Practical implications

The paper’s findings provide insights to help make the design, management and monitoring of smart contract technology more robust. They also provide guidance for key stakeholders on proactive steps that can be taken with smart contract technology to avoid repeating the types of oversights that contributed to the GFC.

Originality/value

This paper draws attention to the risks associated with the adoption of disruptive FinTech. It also suggests steps that regulators and other key stakeholders can take to help mitigate those risks.

Details

Journal of Financial Regulation and Compliance, vol. 29 no. 1
Type: Research Article
ISSN: 1358-1988

Keywords

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Article

Katherine Tyler and Edmund Stanley

In 1997, in this journal, Elizabeth Sheedy published a paper investigating exchange relationships in derivative markets. This paper was significant for two reasons. It was…

Abstract

In 1997, in this journal, Elizabeth Sheedy published a paper investigating exchange relationships in derivative markets. This paper was significant for two reasons. It was the first article to consider the marketing of these important financial instruments. Second, her article set out a forceful argument that relationships in this context were breaking down, and that the advantages associated with a relationship model of exchange had not appeared, and indeed had to some extent facilitated the series of well publicised derivative disasters. In this paper, the authors respond to Sheedy’s call for further research through an empirical examination of the over‐the‐counter equity derivatives market in the USA and Britain, arguing that while relationships in this market do, to a limited degree, exhibit characteristics atypical of wider financial services contexts, the relationship paradigm continues to be relevant, and indeed inherent, to over‐the‐counter derivative exchange.

Details

International Journal of Bank Marketing, vol. 20 no. 2
Type: Research Article
ISSN: 0265-2323

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Article

Stan Cerulus

The purpose of this paper is to answer a specific research question: How have EU and US regulators translated the idea of central clearing into law?

Abstract

Purpose

The purpose of this paper is to answer a specific research question: How have EU and US regulators translated the idea of central clearing into law?

Design/methodology/approach

A meticulous legal research is carried out. First, the pre‐crisis regulatory regime for credit default swap (CDS) is reviewed, from a securities law angle as well as from a comparative Euro‐American perspective. Next, the regulatory processes leading to the adoption of the central clearing regulations are discussed. Thereafter, a material comparative analysis is made of the provisions related to central clearing in the EU and US regulatory initiatives. Finally, the paper is concluded with an evaluation of both legislations in the light of all previous analyses.

Findings

The research first shows that central clearing regulations rely on a series of presumptions, both concerning the gravity of counterparty risk threats and the necessity of central clearing. Additionally, the EU and US clearing regulations are similar with regard to the broad innovations they introduce, i.e. the mandatory central clearing of a variety of over‐the‐counter derivatives and counterparty risk management requirements for central clearing institutions and for non‐cleared swaps. However, the specific content of the provisions often differs. Furthermore, both legislations are limited to enouncing broad principles. This is also the case for the crucial provisions related to counterparty risk management. Therefore, these provisions in se do not guarantee the proper regulation of counterparty risk management practices. Consequently, much is to be expected from the implementing measures adopted by regulatory institutions.

Originality/value

The paper provides an overview of those provisions in the European and US regulations that specifically concern central clearing for CDS. It is one of the first papers which does this in a very well‐structured and clearly written manner. Also it is one of the first to provide a clear comparison between the provisions in the EU and the US regulations.

Details

Journal of Financial Regulation and Compliance, vol. 20 no. 2
Type: Research Article
ISSN: 1358-1988

Keywords

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Article

Tim Aron, Nathaniel Lalone and Carolyn Jackson

The purpose of this paper is to explain the European Market Infrastructure Regulation, known as EMIR, adopted on July 4, 2012 as the Regulation on OTC Derivatives, Central…

Abstract

Purpose

The purpose of this paper is to explain the European Market Infrastructure Regulation, known as EMIR, adopted on July 4, 2012 as the Regulation on OTC Derivatives, Central Counterparties and Trade Repositories.

Design/methodology/approach

The paper explains EMIR's clearing and reporting requirements, who is within the scope of those requirements, who is a financial and non‐financial counterparty, the clearing thresholds, the clearing and reporting obligations, when those obligations will begin, the risk mitigation obligations, and a range of potential questions anyone trading in OTC derivatives should consider.

Findings

EMIR requires that all standardized OTC derivatives contracts be cleared through a central counterparty and reported to a trade repository.

Originality/value

The paper provides practical guidance by experienced financial services lawyers.

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Book part

Jing Chi and Martin Young

While China is currently moving toward the full development of its own financial derivatives markets, to date, China's experience with these has been a negative one. This…

Abstract

While China is currently moving toward the full development of its own financial derivatives markets, to date, China's experience with these has been a negative one. This paper examines the importance to China of developing a fully integrated financial derivatives market from both the economic and financial market perspectives. It examines the best way forward for derivative trading, both market based and over-the-counter, and the types of products best suited to both, given the current state of the Chinese financial markets. Consideration is given to market structure, regulation, trading and settlement systems and international cooperation.

Details

Asia Pacific Financial Markets in Comparative Perspective: Issues and Implications for the 21st Century
Type: Book
ISBN: 978-0-76231-258-0

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Article

Andreas A. Jobst

Amid benign monetary policy in mature market countries and high liquidity‐induced demand, lower risk premia have encouraged risk diversification into alternative asset…

Abstract

Purpose

Amid benign monetary policy in mature market countries and high liquidity‐induced demand, lower risk premia have encouraged risk diversification into alternative asset classes outside the scope of conventional investment. The development of derivative markets in emerging economies plays a special role in this context as more institutional money is managed on a global mandate, with more and more capital being dedicated to emerging market equity. This paper aims to focus on these issues.

Design/methodology/approach

This paper reviews the recent development of equity derivative markets in emerging Asia and informs a critical debate about market practices and prudential supervision. Goal of the paper is also to outline essential elements and key policy considerations in developing derivative markets.

Findings

The supervision of emerging derivative markets depends on the expedient and tractable resolution of challenges arising from consistent risk management, risk mutualization, and prudential standards that guarantee market stability in crisis situations. In particular, further efforts are needed in areas of cash market liquidity, trading infrastructure as well as legal and regulatory frameworks based on a set of coherent principles for capital market development.

Originality/value

The paper offers a comprehensive set of principles for the development of equity derivative markets based on the current state of equity derivative trading in emerging Asia. Given current efforts by national regulators in the region to implement comprehensive guidelines on derivatives and revise short selling restrictions, the scope of this paper has topical appeal from the perspective of market participants and regulators.

Details

International Journal of Emerging Markets, vol. 3 no. 2
Type: Research Article
ISSN: 1746-8809

Keywords

Abstract

Details

Financial Derivatives: A Blessing or a Curse?
Type: Book
ISBN: 978-1-78973-245-0

Content available
Article

Young Sook Suh

This study examines how FX OTC derivatives transactions of foreign banks’ branches funded by short term borrowings affect the volatility of stock markets and FX markets in…

Open Access

Abstract

This study examines how FX OTC derivatives transactions of foreign banks’ branches funded by short term borrowings affect the volatility of stock markets and FX markets in Korea based on historical data. It founds that they use call money for FX-derivatives trading, rather than borrowings from their Head Quarter. This result also proves that their derivatives trading is funded by call market increasing stock markets’ volatility in Korea, even if foreign banks’ branches have been using various funding sources. Also the role of foreign banks’ branches as FX money supplier for the korean local banks effects to stock markets by increasing the volatility via call markets. On the other hands, derivatives liabilities of foreign banks’ branches tend to increase volatility of the korean stock markets, but their derivatives assets tend to decrease the volatility. This result together with O/N dollar call volatility should be regarded as a kind of liquidity risk because they could give serious impacts to Korean financial markets if shocks break out. When considering the main revenue source of foreign banks’ branches, derivatives trading creates much higher leverage effects to them than korean local banks, and their roles in financial and capital markets of Korea this study provides with a reason that regulators should give complex and multilateral attentions to foreign banks’ branches.

Details

Journal of Derivatives and Quantitative Studies, vol. 23 no. 1
Type: Research Article
ISSN: 2713-6647

Keywords

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Book part

Mohamed Rochdi Keffala

The collapse of Italian economy has coincided with the global financial crisis to which derivatives are suspected to be responsible of its propagation. For this reason…

Abstract

The collapse of Italian economy has coincided with the global financial crisis to which derivatives are suspected to be responsible of its propagation. For this reason, this study aims to examine whether the use of derivatives affects the profitability of Italian banks during both the global financial crisis period and the recession period of Italian economy. To reach this goal an appropriate econometric procedure namely the dynamic Generalized Method of Moments system is applied using data from 22 Italian banks over the long period 2005–2017. A series of bank-specific indicators are used to explain the effect of overall derivatives and each derivative instrument separately on Italian banks’ profitability. The results of regressions panels indicate that in general derivatives as well as measured in the whole or splitting up in instruments specifically in forwards, options, and, in particular, swaps affect positively the profitability of Italian banks. The main conclusion is that – despite the episode of economic recession in Italy – Italian banks boost their profitability by using derivatives.

As practical contribution, policy-makers in Italy should throw out the assumption of the implication of derivatives in the fragility of the banking system. On the contrary, they should pave the way easily for Italian banks’ managers to deal with derivatives and look out for the real problems of the recent collapse of the Italian economy.

Details

Essays in Financial Economics
Type: Book
ISBN: 978-1-78973-390-7

Keywords

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