Mitigating systemic risk in OTC derivative markets

The financial crisis has demonstrated that turmoil in OTC derivative markets can exacerbate financial distress. One of the challenges policymakers currently face, is to mitigate the risks these markets pose to the financial system. Inducing a shift towards more central clearing is an important step in the right direction as it tempers counterparty risk and increases transparency. However, this will only be part of the solution as risk management systems of Central Counterparties (CCPs) are not necessarily equipped to clear all types of derivative contracts. In addition, central clearing concentrates risk and may actually increase systemic risk. By implication, it is crucial that CCPs have robust risk management systems in place. Furthermore, enhancing the safety and transparency of bilateral clearing also merits attention as a certain share of OTC derivative trades will remain bilaterally cleared. Given the international character of OTC derivative markets, coordination between national supervisors and regulators is crucial for any initiative to succeed.