Derivatives Clearing May Increase Risks, Morgan Stanley Says

Mandatory clearing of derivatives may inadvertently increase counterparty risk, according to James Hill, a managing director at Morgan Stanley.

Regulators have argued that more derivatives trades should be centrally cleared to limit the fallout if a counterparty defaults. Separating trades that can be centrally cleared from those that can’t introduces counterparty exposure that may otherwise be offset, Hill said at the International Swaps & Derivatives Association’s annual meeting in Prague today.

“You have a bifurcation of your book between trades that are cleared and those that are not cleared,” he said. “That’s magnified by the problem that within cleared trades you have multiple clearing houses.”

That may increase the cost of trading and reduce liquidity in the market, Hill said.

“I expect that as the market progresses and dealers start to think about where they’re warehousing risk, they will make a different price for the exact same trade based on where it clears,” he said.

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