BRUSSELS/LONDON, July 6 Global regulators launched a consultation with the financial services industry on Friday to shape new rules on how much banks should set aside to cover the risk of default on uncleared derivatives deals in the $648 trillion market.
It is one of the final pieces of a sweeping reform of derivatives markets that world leaders called for by the end of 2012, after derivatives played a central role in the 2007-09 crisis, which led to the collapse of Lehman Brothers.
The proposals will affect trillions of dollars of transactions, bumping up costs for users and leaving smaller financial players out in the cold, while bolstering banks with deep pockets, industry experts said.
The Basel Committee on Banking Supervision and the International Organisation of Securities Commissions consultation aims to identify how much margin or collateral, such as cash or highly-liquid securities, a derivative trader must put by to cover risks.
Just 15 dealers - including BNP Paribas, Deutsche Bank, Goldman Sachs, HSBC, Morgan Stanley, Societe Generale, and UBS - account for more than 80 percent of trading in derivatives.
Derivative contracts like interest rate or credit default swaps are used to hedge or insure against risks such as unexpected moves in interest rates or a default by a company or country.
Most derivatives trading is between banks that typically do not post an initial margin on uncleared contracts.
The consultation paper proposes a standardised margin requirement of between 2 and 15 percent of the size of the trade, depending on the type of asset, as well as its maturity.
The aim is to cover the risks from the contract and to create a financial incentive to use a clearing house.
A clearing house creates a transparent trail for a trade and is backed by a default fund so that a transaction is completed even if one party to a deal goes bust.
The final piece in the derivatives puzzle is expected during the summer, when the Basel Committee will publish how much capital banks must have to cover their cleared derivatives contracts. Currently, no capital is set aside in many cases.
The amount of capital needed to cover a trade at a clearing house will hinge on the size of the 'risk weight' which, in turn, will depend on whether the clearer meets tough new rules to ensure its robustness.
The margin requirements will create huge demand, upwards of several trillion dollars according to some estimates, for high quality assets to serve as collateral.