Incentives to centrally clear over-the-counter (OTC) derivatives A post-implementation evaluation of the effects of the G20 financial regulatory reforms – final report 19 November 2018 The Financial Stability Board (FSB) is established to coordinate at the international level the work of national financial authorities and international standard-setting bodies in order to develop and promote the implementation of effective regulatory, supervisory and other financial sector policies. Its mandate is set out in the FSB Charter, which governs the policymaking and related activities of the FSB. These activities, including any decisions reached in their context, shall not be binding or give rise to any legal rights or obligations under the FSB’s Articles of Association. Contacting the Financial Stability Board Sign up for e-mail alerts: www.fsb.org/emailalert Follow the FSB on Twitter: @FinStbBoard E-mail the FSB at: [email protected] Copyright © 2018 Financial Stability Board. Please refer to: www.fsb.org/terms_conditions/ Contents Page Abbreviations used in this report ............................................................................................... v Part A Executive summary ..................................................................................................... 1 Part B Introduction and context to the DAT ........................................................................ 6 B1 Background and motivation for the DAT study .............................................................. 6 B2 Post crisis regulatory goals .............................................................................................. 7 B3 Objectives and scope ..................................................................................................... 10 B4 Data and methodology ................................................................................................... 11 Part C The current state of the OTC derivatives markets ................................................ 16 C1 Entities participating in clearing .................................................................................... 16 C2 Clearing rates and levels ................................................................................................ 17 C3 Clearing rates and levels around the implementations of the clearing mandate and margin requirements for uncleared derivatives ................................................................................ 19 C4 Client clearing service provision ................................................................................... 21 Part D Analysis of the incentives to centrally clear OTC derivatives .............................. 25 D1 Introduction ................................................................................................................... 25 D2 Incentives to centrally clear as reported by survey respondents ................................... 25 D3 Introduction to the quantitative survey .......................................................................... 28 Box 1 Summary of quantitative survey analytical inputs and outputs ................................ 30 D4 All-in cost comparison for interest rate swaps .............................................................. 32 D5 All-in cost comparison for clients who trade less frequently ........................................ 33 D6 All-in cost comparison for other asset classes ............................................................... 34 D7 Cost comparison under bilateral variation margin only ................................................ 36 D8 Bilateral trades without two-way exchange of margin .................................................. 37 D9 Discussion of cost advantages due to differences in initial margin requirements ......... 38 iii D10 Discussion of cost advantages observed in trade repository data ............................... 41 D11 The impact of the clearing mandate ............................................................................ 42 D12 Views on voluntary clearing from survey respondents ............................................... 45 D13 The scope of the clearing mandate .............................................................................. 45 D14 Avoiding the clearing mandate .................................................................................... 46 Part E Access to central clearing ......................................................................................... 48 E1 Access to clearing services and restrictions on activity ................................................. 49 E2 Clearing fees .................................................................................................................. 51 E3 The changing business model of client clearing ............................................................ 52 E4 Concentration of client clearing service providers and portability ................................ 53 Part F Reform analysis and issues in incentivising clearing ............................................. 55 F1 Cost-benefit considerations ............................................................................................ 55 Box 2 The role and risks of central clearing of OTC derivatives........................................ 56 F2 The benefits of reforms .................................................................................................. 57 F3 The costs of reforms ....................................................................................................... 60 F4 The transmission mechanism from changes in regulatory requirements to financial system activity 60 Box 3 OTC trade compression: An example of optimisation under constraints ................. 61 F5 The leverage ratio ........................................................................................................... 62 F6 The G-SIB methodology ................................................................................................ 68 F7 Other issues .................................................................................................................... 70 Annex 1 DAT data sources and inputs .................................................................................... 76 Annex 2 Background on other pertinent standards ................................................................. 81 Annex 3 Research discussion .................................................................................................. 87 Annex 4 Additional methodology, charts and data from survey analysis ............................... 96 Annex 5 Additional insights from qualitative survey responses ........................................... 101 Annex 6 Calculation of clearing costs ................................................................................... 107 iv Abbreviations used in this report BCBS Basel Committee on Banking Supervision BIS Bank for International Settlements CCP Central counterparty CCSP Client clearing service provider CDS Credit default swap CEM Current exposure method CGFS Committee on the Global Financial System CPMI Committee on Payments and Market Infrastructures CSA Credit support annex CVA Credit valuation adjustment DAT Derivatives Assessment Team DVA Debt (or debit) valuation adjustment ETD Exchange traded derivative FCM Futures commission merchant FRA Forward rate agreements FSB Financial Stability Board FVA Funding valuation adjustment FX Foreign exchange G-SIB Global systemically important bank IM Initial margin IMM Internal model method (or International Money Market, when referring to interest rate swap date conventions) IOSCO International Organization of Securities Commissions IRS Interest rate swap KVA Capital valuation adjustment LEM Leverage exposure measure MPOR Margin period of risk MVA Margin valuation adjustment NDF Non-deliverable forward OIS Overnight indexed swaps OTC Over-the-counter PFE Potential future exposure QCCP Qualifying central counterparty RC Replacement cost RWA Risk weighted asset SA-CCR Standardised approach for counterparty credit risk SIMM Standard initial margin model SSB Standard setting body TR Trade repository UMR Uncleared margin requirements VM Variation margin v Incentives to centrally clear OTC derivatives A post-implementation evaluation of the effects of the G20 financial regulatory reforms Part A Executive summary The FSB and the other standard-setting bodies (SSBs) (i.e. the Basel Committee on Banking Supervision, the Committee on Payments and Market Infrastructures, the Financial Stability Board and the International Organization of Securities Commissions) reconvened the Derivatives Assessment Team (DAT) to “re-examine whether adequate incentives to clear centrally over-the-counter (OTC) derivatives are in place” as one of the first evaluations under the FSB framework for the post-implementation evaluation of the effects of the G20 financial regulatory reforms. This report sets out the DAT’s findings. A consultative document was published in August 2018.1 The central clearing of standardised OTC derivatives is a pillar of the G20 Leaders’ commitments to reform OTC derivatives markets in response to the financial crisis. A number of post-crisis reforms are, directly or indirectly, relevant to incentives to centrally clear. These include mandatory clearing requirements; capital, liquidity and margin requirements relating to OTC derivatives activity; and reforms relating to the resilience, recovery and resolution of central