CCPs And Collateral

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With Shane Worner, Senior Economist, IOSCO
With regard to ongoing issues in the next year or so, I have identified two main areas of concern – CCPs and collateral transformation.
We are essentially moving risk from banks into CCPs. The fundamental question is whether CCPs are able to price the risk as well as banks can. We are therefore creating an issue that will ultimately become too big to fail.
If we look at the issue of collateral management, the one area that will need more attention is collateral transformation. By putting in stringent requirements for OTC derivatives and other regulatory reforms, we are moving the risk back into those entities that are undertaking the transformational process.
For example, take someone with high value corporate bonds who wants to swap them for triple A sovereign debt. The risk differential between those two products needs to be transferred elsewhere. The other person is not holding it anymore. The person is doing the transformation. We need to shed more light on that actual practice in order to make it more transparent.
In the wake of the financial crisis, CCPs were mandated to help with the promotion of financial stability. If you believe that financial stability is a public good then these entities ideally would be government owned, but at a minimum should be a not-for-profit entity with a natural market monopoly.
Currently, they are private entities with a profit motive and face competition in their respective markets. Basic economics would predict that this could cause significant issues, especially if CCPs compete on eligible collateral and move collateral investment down the maturity ladder to take business away from competitors.
Even a profit based entity with no competitors extracting a monopoly rent might be the tax the market has to pay to increase financial stability.