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New rules outlined under the Dodd-Frank Act in the US and European Market Infrastructure Regulation in Europe in the wake of the global financial crisis will force most over-the-counter derivatives through clearing houses in order to manage risk better. The rules will have dramatic operational implications for the big banks and brokerages that interact with the clearing houses on a daily basis.
According to analysts and bankers, existing back-office bank IT infrastructure is not equipped to deal with the demands of shifting OTC derivatives through clearing. While OTC clearing already takes place in the energy and interest rate swap markets, many banks and dealers will have to tool-up if they are to cope with the speed, scale and complexity of the post-crisis OTC clearing environment, says Kiri Self, chief executive of post-trade services at consultancy The Realization Group, and a former member of the London Stock Exchange’s clearing team. She said: “While millions have been spent on improving front-end technology, the same can’t be said for the back office, where manual processes still prevail. Now that we’re getting to the stage where OTC clearing is going to be used much more, huge amounts of investment are going to be needed to bring back offices up to speed.”
The move to a real-time environment, which will enable firms to manage their exposure more efficiently and accurately, also represents an operational step-change for many firms. Margin calls, whereby a counterparty demands collateral in order to secure a trade, are a key problem in this respect. In the bilateral OTC world, margin calls can take days if one party queries the amount of money being demanded, but in the cleared world firms must respond on an intra-day basis.
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