Friday, February 12, 2010

Infrastructures must become more resilient

Author: David Schwartz J.D. CPA David Schwartz J.D. CPA

Organized exchanges and central counterparty structures are expected to lower the threat from opaque, concentrated trading networks.

Bank for International Settlements: A key way to lessen the systemic risks created by large, interconnected firms is to put in place more resilient market structures. Trading of financial derivatives on organised exchanges is one way. Another is to replace the web of bilateral exposures with robust central counterparties (CCPs). This can reduce the risk of common exposures in several ways. A CCP is an entity that interposes itself between the two sides of a transaction, becoming the buyer to every seller and the seller to every buyer; this contributes to greater liquidity in the market and reduces contagion effects. A CCP also addresses default risk by requiring each participant to hold a margin account in which the balance is determined by the value of the participant's outstanding contracts: the more volatile the market, the larger the required margin balance and the more expensive it becomes to hold large positions. Furthermore, channelling transactions through a single platform enhances the collection and dissemination of information. This in turn allows market participants and the authorities to monitor the concentration of individual exposures and the linkages that they create.[1]

[1] Mr Jaime Caruana, General Manager of the BIS, “Systemic risk: how to deal with it?”, 12 February 2010