The paper explores the three major sources of disruptive effects in OTC derivatives: liquidity, counterparty risk and legal uncertainty. It also finds that the EU and US proposals are divergent and the author warns that such divergences may encourage regulatory and supervisory arbitrage.
Now that the worst of the financial storm is over, regulators are setting new strategies to deal with the systemic importance of the €427 trillion ($604 trillion) over-the-counter (OTC) derivatives market. This paper explores the three major sources of disruptive effects in OTC derivatives: liquidity, counterparty risk and legal uncertainty. These risks affect the value chain of a typical derivative transaction and weaken the economic and legal rationale behind their widespread use. On the policy side, commitments have been made at G-20 level to draft uniform rules on a global scale “to build a safer financial system”. This paper finds, however, that in practice, the EU and US proposals lay out divergent roads to meet common objectives and the author warns that such divergences may encourage regulatory and supervisory arbitrage.
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