Derivatives clearinghouses should standardize and report more information on risk management practices so bank members can assess the threats they face, according to a report sponsored by the Federal Reserve Bank of New York.
Clearinghouses, which are meant to lessen the effect of default by requiring collateral and marking positions daily so losses don’t build, should make information available on how operations are governed, margin is set, defaults are managed and the credit of bank members is monitored, according to the report today by the Payments Risk Committee, a group of banks including JPMorgan Chase & Co., Goldman Sachs Group Inc., Morgan Stanley and UBS AG.
“The ultimate goal is that clearing member banks will not only have the tools and data necessary to better evaluate specific risks that they face, but that in so doing all market participants will better understand the unique and critically important role played by” clearinghouses, the report said. That will enable “potential systemic risks to be addressed before they have the opportunity to surface.”
Clearinghouse owners that participated in the creation of the report included CME Group Inc., Intercontinental Exchange Inc., LCH.Clearnet Group Ltd., the Depository Trust & Clearing Corp., Eurex AG and the Options Clearing Corp. The 2010 Dodd-Frank Act requires most interest-rate, credit-default and other swaps to be processed by clearinghouses to reduce systemic risk and offer regulators more information about market participants. The report’s recommendations are voluntary and non-binding, the Payments Risk Committee said.
The move to obtain more information from clearinghouses started last year in non-public meetings as Citigroup Inc. and JPMorgan pushed CME Group, Intercontinental and LCH to reveal more about their finances and risk-management policies, people with knowledge of the matter said last year. Lenders also want to know more about whether collateral is being calculated correctly, according to an executive at a large dealer. They asked not to be named in order to speak candidly.
Banks want to make sure they “don’t find out at the moment of maximum fail potential” that clearinghouses haven’t kept enough capital, Paul Galant, a Citigroup executive who leads the New York Fed’s Payments Risk Committee, said at the time. Galant was not listed as participating in the report issued today.
Clearinghouses cut risk by collecting collateral at the start of each transaction, monitoring daily price moves and making traders put up more cash as losses occur. Traders have to deal through clearing members, typically the biggest banks and brokerages. Unlike privately traded derivatives, prices for cleared trades are set every day and publicly disclosed.
The role of clearing was expanded by Dodd Frank based on the track record of clearinghouses during the 2008 credit crisis. The idea took hold after Lehman Brothers Holdings Inc. failed in 2008 and LCH settled $9 trillion of derivatives linked to interest rates held by the New York-based investment bank. LCH needed only about two weeks and 35 percent of the collateral Lehman had posted, Dan Maguire, head of U.S. operations at LCH’s SwapClear service, said last year.
Derivatives help investors hedge or speculate on commodity prices, interest rates or, in the case of credit-default swaps, the financial health of firms or nations. “Swaps” is Wall Street’s shorthand for bets in which investors swap payments back and forth with each other during the life of a derivative as prices rise and fall on the specified asset. Some contracts can last for a decade or more.