Central Clearing Requirement to Collide With Counterparty Exposure Limit

Market participants and industry groups are expressing concern over a Fed proposal to limit counterparty exposure that may interfere with soon-to be implemented central clearing requirements for standardized OTC derivatives.

Because the Fed proposal, which would cap exposure to a single counterparty at 25% of a bank’s capital, does not exclude central counterparties (CCPs), it could mean that firms trading a large volume of derivatives could be forced to clear with more than one CCP. The danger is hardly theoretical: a CME Group comment letter filed April 30 estimated that two of its member firms were already approaching, or were in excess of, the single-party credit limit.

Industry groups such as SIFMA initially supported single-counterparty exposure limits, but are now calling for CCPs to be exempt from the final rules.

“When Dodd-Frank was being debated, industry was in favor of single counterparty redit limits because we’d been using them for 15 or 20 years as part of our toolbox of things firms use to manage risk.” Carter McDowell, managing director and associate general counsel at SIFMA, said. “We were happy that this was included because we thought it’s an effective risk management tool. The problem was when we saw this proposal, it basically was nothing like what we were doing. So in areas such as derivatives where firms are doing a lot of internal risk modeling, the Fed decided they were going to craft their own model. And unfortunately for us, the model they crafted is very crude.”

Read more.

Photo credit: Tim Herrick

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