60 n the trade derivatives n issue 4 n Q3 2013 n www.thetradenews.com
Systemic risk
n The TRADE Derivatives forum
While this will make
banks safer, it will reduce
banks’ ability to step in and
take risk, increasing market
volatility during periods of
market dislocation and shock.
It will also mean that when
interest rates rise as quantitative easing ends, price volatility will have to be more significant to draw in non-bank
actors, such as hedge funds
and proprietary trading firms
to absorb this liquidity.
The introduction of CCPs
is welcome and should reduce
systemic risk, however there
is also a downside to concentrating assets within clearing
houses. If competitive pressures force CCPs to lower
margin requirements to too
low a level, it could lead to a
default which would in turn
result in the spreading of contagion witnessed in 2008.
But just because banks are
systemically less risky, it doesn’t
mean that risk disappears. The
risk just gets spread from banks
to hedge funds, proprietary
trading firms and corporations. Stringent attention must
be applied to ensure that bank
deleveraging and de-risking
does not concentrate outside
of regulated entities and create a series of hidden risks that
won’t be known until something goes horribly wrong.
Dodd-Frank and European
market infrastructure regulation have concentrated on
limiting the contagion and
bilateral linkages that exacerbated the crisis. The products
that sparked the crisis, such as
collateralised debt obligations
and mortgage syndication
products, have largely evaded
regulatory reform, but have
become less popular.
Regulatory frameworks
in the US and Europe have
placed the industry in a
stronger position than
before 2008, but it’s not clear
whether risk is actually better
managed now, despite being
more visible.
Greater transparency of
participants’ exposures is beneficial to the market and in
conjunction with greater bank
capitalisation, means assets are
more accurately valued and
supported by collateral should
an adverse event take place.
The large-scale change
witnessed since 2008 has
increased the industry’s
capacity to handle risk, but
avoiding another crisis will
depend on the industry
understanding banks’ new
limitations, capital requirements, and the risk practices
of clearing houses.” n
LARRY TABB
continued