Wednesday, August 31, 2016

BIS and IOSC Issue New Report on Derivative Clearing House Problems

The potential for a derivatives related failure to trigger another major global financial crisis has been discussed here for some time. Both the IMF and the BIS have issued warnings in the past related to the situation which are included on our page documenting various such warnings

The Bank for International Settlements (BIS) and the International Organization of Securities Commission (IOSC) have now issued a new report that says that many years after the 2008 crisis, there are still gaps and concerns related to derivatives transactions. This article in the Financial Times details the new report. Below are a couple of selected quotes from the FT article and then some added comments.

"Some of the world’s largest clearing houses are failing to meet global standards to withstand derivatives trading shocks, the world’s most powerful markets watchdog has found.

Four years after guidelines were introduced, a survey of 10 derivatives clearing houses found that some did not have sufficient policies or procedures to ensure they had enough money to keep going, or to replenish diminished reserves. Others needed to improve their stress tests, the report said."

. . . . 

Clearing houses act as market utilities, ensuring a deal is completed if one party defaults — they have become a vital part of policymakers’ efforts to reform global trading. Authorities have mandated that more risk management of the over-the-counter derivatives market be transferred from banks to clearing houses. These risk managers have now been labelled the global markets’ new “too big to fail”.

My added comments: Here we are many years after the last big crisis in 2008 and it is clear that there are still serious risks to the stability of the present financial system out there. Please note that this was a limited study of only 10 clearing houses that are expected to be able to withstand a default related to derivatives transactions they handle. This study found ongoing gaps and problems in several of these 10 and said they needed to be fixed by year end 2016. 

Of course we know there are many more out there including those involved in unregulated "Shadow Banking" which the IMF has warned about in the past

Bottom line: While it is true that some steps have been taken to try and improve the situation related to derivatives risk to the entire system, by no means are the risks now gone. This is just one type of event (among others) that could trigger a systemic crisis. A reader here sent me this article which talks about another. This is why we have to remain alert and stay informed. It's not fun or easy, but must be done given the legitimate risks that do exist. On 9-1-16 we will run our monthly Crisis Watch Update. There is not much new to report, but there are a few new items readers may find of interest.

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