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OTC derivatives market needs global central counterparties, says City of London report

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The over the counter derivatives market is a global market and needs global central counterparties, according to a report from Bourse Consult, published by the City of London Corporatio

The over the counter derivatives market is a global market and needs global central counterparties, according to a report from Bourse Consult, published by the City of London Corporation.

The report says the US and the European Commission should not try to create regional central counterparties for OTC derivatives. London has 43 per cent of the global OTC derivatives market by value, whilst the US has 24 per cent.

The report suggests that collateralised debt obligations on asset backed securities, sold into highly leveraged structured investment vehicles and held off banks’ balance sheets, were the major guilty parties in the financial crisis.

By contrast, the report finds little evidence that credit default swaps – which were traded far more widely than CDOs – contributed significantly to the crisis. The report also makes recommendations for future regulation of the OTC derivatives market in the US and EU.

The conclusions of the report have been endorsed by Robin Johnson, corporate partner at law firm Eversheds, who says: ‘Derivatives are an essential part of a fully functioning market. Their role of spreading risk allows providers of first level finance to continue to provide essential resources.

‘A number of issues are affecting the derivatives market at the moment. For example, with interest rates being driven down earlier this year margins have become wafer-thin, resulting in even a small default leading to a tsunami.

‘Furthermore, fair value accounting rules lead to valuations of derivatives becoming capable of being artificially inflated in a thinly-traded market and insurance companies become the ultimate risk bearer, fuelling more and more trading. This has also been driven by the lack of disclosure in interlocking positions.

‘Rather than regulation of the products themselves, the focus should be disclosure and governance of risk management policies of financial institutions engaged in derivative trading.’

The City of London Corporation provides local government services for the Square Mile, the financial and commercial heart of Britain. The corporation works nationally and internationally to maintain and enhance the City as a world-leading international financial and business centre.

Click here to read the report.

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