A bill set to establish central counterparties to clear over-the-counter derivatives has been approved in South Korea. Xinhua News Agency reports that South Korean lawmakers passed the revised bill on capital markets act that will allow the establishment of central counterparties (CCPs) for the clearing of over-the-counter (OTC) financial derivatives. The law will require clearing for interest-rate swaps and other OTC derivatives.

South Korea and OTC Derivatives

According to the Financial Services Commission (FSC) the nation’s legislators in charge of related matters passed the bill that will enable the OTC derivative CCPs to be set up in as little as three months.

Derivatives such as interest rate swap (IRS) whose default could potentially have a significant impact on the overall market, will be required to settle contracts through the registered CCPs.

Though forced, the clearing is expected to reduce counterparty risks, preventing the default of one market participant from causing collapse of other market players as seen in the 2008 global financial crisis.

According to Xinhua, South Korea’s OTC derivatives market reached 6,904 trillion won – 6.32 trillion U.S. dollars – at the end of 2011. This was nearly 100 times the size of listed derivatives markets, and the interest rate swap market accounted for almost two-thirds of the total OTC products.

This revised bill is part of the Financial Investment Services and Capital Markets Act (FISCMA) which was introduced in June 2011 to assist large investment banks, and to facilitate the adoption of alternative trading systems. The act failed to be fully passed until this week.