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Article
Publication date: 11 September 2009

Joel Telpner and Jamila Piracci

The purpose of this paper is to explain and analyze recent US Congressional, Obama Administration, and financial services industry initiatives to reform and regulate the…

Abstract

Purpose

The purpose of this paper is to explain and analyze recent US Congressional, Obama Administration, and financial services industry initiatives to reform and regulate the market for OTC derivatives.

Design/methodology/approach

The paper outlines Congressional committee bills, other Obama Administration initiatives, and industry self‐regulatory initiatives and discusses underlying current issues such as which derivatives would and would not have to be cleared through central counterparties (CCPs); how standardized and customized derivatives would be distinguished from each other; potential margin, business conduct, reporting, and recordkeeping standards for OTC derivatives dealers; how fraud, market manipulation, and other market abuses would be policed; possible limitations on the types of parties that may participate in unregulated derivatives; possible resolution of the sometimes confusing and overlapping authority of the SEC and CFTC over OTC derivatives; how and by which federal or state authority credit default swaps (CDS) might be regulated; the potential for regulatory arbitrage; and the danger that stringent regulation in the USA will drive OTC derivatives business offshore.

Findings

Unlike markets for other financial instruments, derivatives market participants, largely through ISDA, have for some time cooperated closely with the New York Fed and engaged in a myriad self‐policing activities. Time will tell whether this existing framework, combined with the redoubled self‐policing efforts of market participants, will cause policymakers to seek appropriate legislation that will not threaten the preservation of the OTC derivatives market in the USA.

Originality/value

The paper presents a clear and detailed guide and explanation of recent regulatory initiatives and underlying issues.

Details

Journal of Investment Compliance, vol. 10 no. 3
Type: Research Article
ISSN: 1528-5812

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Article
Publication date: 18 October 2011

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

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Article
Publication date: 13 January 2020

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
Publication date: 3 May 2013

Siona Listokin‐Smith

The purpose of this paper is to examine the probable structure of bilateral derivatives contracts following international regulatory reforms.

Abstract

Purpose

The purpose of this paper is to examine the probable structure of bilateral derivatives contracts following international regulatory reforms.

Design/methodology/approach

The theoretical context of the paper is private and meta‐regulation, which the author applies to a case study and current industry analysis.

Findings

While regulations are still being written, it is likely that elements of oversight for the bilateral derivatives market will involve enforced self‐regulation. When combined with more specific outcome‐oriented regulatory requirements, the industry is well‐suited to this type of coordinated regulatory regime.

Practical implications

In light of the uncertainty of derivatives regulation and the future size of the bilateral, over‐the‐counter (OTC) derivatives market, practitioners should consider a likely broader range of regulation structures.

Originality/value

The paper fills a gap in the literature about non‐traditional governance structures for the derivatives markets following the financial crisis. Rather than considering regulation on a light/heavy axis, the paper examines whether this segment of the market can sustain a process‐oriented regulatory arrangement.

Details

Journal of Financial Regulation and Compliance, vol. 21 no. 2
Type: Research Article
ISSN: 1358-1988

Keywords

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Article
Publication date: 28 June 2013

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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Article
Publication date: 14 May 2018

Chiara Oldani

The purpose of this paper is to underline the (hidden) risks posed after the crisis by the exemption of non-financial operators, especially sovereigns, from the regulatory…

Abstract

Purpose

The purpose of this paper is to underline the (hidden) risks posed after the crisis by the exemption of non-financial operators, especially sovereigns, from the regulatory reforms of over the counter (OTC) derivatives undertaken by G20 countries in the absence of accounting data on trading.

Design/methodology/approach

Recent financial regulatory improvements are reported to underline that the trading of OTC derivatives by sovereigns and local administrations does not take place under the new regulatory umbrella, because of the relative size of the institution, the lack of incentives to adhere to Centralized Counterparty Systems (CCPs) and most of all, the absence of proper accounting rules. Sovereigns and local administrations have the potential to undermine global financial stability.

Findings

The limited availability of accounting data on derivatives’ use by public administrations constitutes a barrier towards a full comprehension of risks involved. Sovereigns should be compelled to adhere to the CCPs and the collateralized system of trading; the short-term costs of adhering to CCPs are worth $20bn.

Research limitations/implications

The new regulatory system failed to explicitly consider the trading of sovereigns and this can reduce the effectiveness of regulation itself and can have negative impact on financial stability; in fact, omitting sovereigns from these regulations represent a significant risk oversight because they are systemically important players, although with a special political power.

Originality/value

Despite progress made in improving the transparency and resilience of OTC derivative markets after the subprime crisis, sovereigns and public administrations are exempted from the new regulation, posing severe risks to financial stability.

Details

Journal of Financial Regulation and Compliance, vol. 26 no. 2
Type: Research Article
ISSN: 1358-1988

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Article
Publication date: 4 May 2012

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
Publication date: 16 June 2010

Robert A. Robertson and Gerardo Perez‐Giusti

The purpose of this paper is to provide an introduction to benefits of using over‐the‐counter (OTC) derivatives when implementing an investment strategy. The paper aims to…

Abstract

Purpose

The purpose of this paper is to provide an introduction to benefits of using over‐the‐counter (OTC) derivatives when implementing an investment strategy. The paper aims to examine the basic legal structure of OTC derivative transactions and the International Swaps and Derivatives Association (ISDA) agreements used to document such transactions. The paper also aims to offer advice to institutional investors on steps they can take during the negotiation of ISDA agreements to reduce associated counterparty, termination and liquidity risk.

Design/methodology/approach

The paper outlines the typical structure of OTC derivative trades; summarizes the documents used to establish a trading relationship, and outlines key considerations for institutional investors during the negotiation of ISDA agreements.

Findings

An institutional investor should carefully review and negotiate ISDA documents to properly implement OTC derivative trades that conform to the investor's overall business operations and investment strategy.

Practical implications

While achieving the benefits of OTC derivative trades, an institutional investor also can negotiate agreements to reduce risks associated with these transactions.

Originality/value

The paper provides practical guidance from experienced securities and derivatives lawyers.

Details

Journal of Investment Compliance, vol. 11 no. 2
Type: Research Article
ISSN: 1528-5812

Keywords

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Article
Publication date: 9 November 2010

Gordon Rausser, William Balson and Reid Stevens

Systemic risk propagated through over‐the‐counter (OTC) derivatives can best be managed by a public‐private central counterparty clearing house. The purpose of this paper…

Abstract

Purpose

Systemic risk propagated through over‐the‐counter (OTC) derivatives can best be managed by a public‐private central counterparty clearing house. The purpose of this paper is to outline the market microstructure necessary for such a clearing house.

Design/methodology/approach

The paper proposes using an request for quote platform with an active permissioning system that uses analytic approximations based on Monte Carlo simulation to estimate default risk and a two‐part pricing scheme to efficiently price that risk.

Findings

It is found that comprehensive clearing for complex and standardized derivatives is feasible using the clearing framework.

Research limitations/implications

This research is limited by the authors' ability to give empirical examples. The paper gives a short example with data, but given the constraints on length, cannot go into more detail.

Practical implications

This comprehensive clearing structure, in contrast to current proposed government regulations, will not drive out the “good” with the “bad” OTC derivative instruments.

Originality/value

This is the only paper the authors are aware of that outlines a detailed framework for clearing all OTC derivatives.

Details

Journal of Financial Economic Policy, vol. 2 no. 4
Type: Research Article
ISSN: 1757-6385

Keywords

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Book part
Publication date: 9 November 2009

Harvey Arbeláez and E.K. Gatzonas

The 2007 BIS Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity Report shows a substantial increase in turnover in foreign exchange and OTC

Abstract

The 2007 BIS Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity Report shows a substantial increase in turnover in foreign exchange and OTC derivatives markets. Turnover in traditional FX markets increased to reach $3.2 trillion. The largest contributor to this 71% increase between April 2004 and April 2007 occurred in FX swaps. It was like a prelude to the financial crisis of 2007–2008 driven by transactions carried out between banks and other financial institutions due to the significance of hedge funds and major engagement of emerging market currencies which have sought new configurations of portfolio diversification worldwide.

Details

Credit, Currency, or Derivatives: Instruments of Global Financial Stability Or crisis?
Type: Book
ISBN: 978-1-84950-601-4

1 – 10 of 202