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Central trading of OTC derivatives stabilises the real economy, says SFI research

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In order to improve market liquidity and financial stability, the G20 countries decided in 2009 that over-the-counter (OTC) products should be centrally traded on electronic platforms.

Recent research results from Swiss Finance Institute (SFI) Professor Harald Hau from the University of Geneva, Peter Hoffmann, and Sam Langfield from the European Central Bank, and Yannick Timmer from Trinity College, Dublin, confirm that such a move will reduce the costs of hedging currency risks for non-financial companies and therefore make an important contribution to risk reduction in the real economy.
The decision of the G20 countries to trade all standardised OTC derivatives via central electronic platforms will in particular affect the foreign exchange market. With a worldwide daily turnover of USD5.1 trillion, it is the world’s largest financial market. Under the current system, dealer banks are not obliged to publicly disclose quotes and prices. Correspondingly, low market transparency results in less sophisticated non-financial clients having to pay significantly higher prices for currency hedging.
The trading of foreign exchange derivatives on electronic platforms, on which a large number of dealer banks are active, counteracts this state of affairs. As the research results show, less sophisticated non-financial clients can benefit from price competition among dealer banks. This makes the current markup disappear and results in uniform pricing across all clients. For SMEs in particular this simplifies access to the OTC market and makes it easier to hedge currency risks. This in turn makes an important contribution to the stability of the real economy.

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