OTC derivatives trades that are not centrally cleared are likely to cost more than centrally cleared transactions. According to BNY Mellon, sovereigns may be better off centrally clearing OTC derivatives trades regardless of statutory requirements, because bank counterparties may charge higher prices on non-cleared bilateral trades which are likely to outweigh clearing costs.
Although it remains uncertain whether sovereign institutions will be swept in under Dodd-Frank’s clearing and reporting requirements, the cost of transacting in non-cleared swaps may be higher than the central clearing costs.
The higher cost of non-cleared transactions for sovereigns stems from Basel 3. Under Basel 3, banks that trade swaps with sovereign entities will likely be required to maintain higher collateral on non-cleared trades. According to BNY Mellon, banks will seek to recover the collateral costs by inflating the price of non-cleared transactions to “the detriment of the sovereign.”
Although theoretically sovereign institutions can avoid Dodd-Frank clearing requirements by avoiding US swap counterparties, doing so would have a detrimental impact on liquidity, risk management, and ultimately pricing, according to Jai Arya, Singapore-based head of the sovereign institutions group at BNY Mellon.
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