12 September 2013

Fed/Dudley: Remarks at panel discussion on OTC derivatives reform and broader financial reforms agenda

Dudley expressed concern that trades may not be standardised to their fullest potential and that the profit incentive of central clearing counterparties may result in a "race to the bottom" in terms of risk controls.

"OTC derivatives reform effort fits in very well with the broader reform agenda, but there are significant risks that we will fall short in this arena relative to what we are likely to achieve elsewhere. As I see it, the G20 reform effort for OTC derivatives has three broad goals:

• Reduce systemic risk with respect to OTC derivatives activities;
• Improve the ability to aggregate and analyse over-the-counter derivatives OTCD risk exposures across markets, institutions and product classes; and
• Improve competition and protect against market abuse.

[...] Despite the progress made to date, I do have some concerns about the OTC derivatives reform effort.  My first concern is about pace. For example, it seems to me that we have made much more progress in strengthening individual institutions through higher bank capital and liquidity requirements than we have made in reducing risk in the OTCD space. Regardless of the cause, because of the slower pace, we are not yet close to a harmonised, robust OTCD system.  Thus, we can’t ascertain whether we have achieved what we set out to achieve—that is, reducing the amount of risk in the system.

I’m also worried that even when we have finished revamping the architecture and regulation of OTC derivatives activities, reform may not go far enough in a number of respects.  First, I am concerned that trades may not be standardised to the fullest degree possible. 

I also worry that implementation of the Principles for Financial Market Infrastructures could falter over time. This could happen for several reasons. In particular, we should recognise that there is a tension between the profit motive of for-profit CCPs and full compliance with the PFMIs. Put simply, some CCPs will prefer to avoid the full costs of compliance.  In other words, there will always be a risk of a race to the bottom, which we must continually push against.

For the global system to be robust, the requirements for CCPs will need to be enforced across the different geographic regimes. I am also worried about fragmentation. In particular, I worry about the proliferation of TRs and CCPs geographically—in some cases in each of the major asset classes. 

Finally, I am worried that we are not going to achieve the full benefits from trade repositories. Regulators, market participants and TRs must continue to work together to ensure that comprehensive, and meaningful data are being reported to TRs and that authorities have the ability to access and analyse the data from the TRs.  

Full speech

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