Comment Text:
Information about compliance with risk management requirements by Derivatives Clearing Organizations (DCOs) which are systematically important is essential as another bulwark against cascading financial systems failures of the type which lead to the financial system stress of 2007-2008 and the demise of several institutions caught up in counter-party risk and unanticipated losses from such risks. The requirement that derivatives be cleared through organizations, to give transparency and reliability to derivatives valuation, liquidity, and risk management is an essential link in the reasonable regulation of the role of derivatives in modern financial systems. In addition, because DCOs are essentially markets providing financial services to derivatives originators and holders, they are in a competitive position with regard to other DCOs and therefore subject to the same types of incentives for weakening, or cheapening, controls and costs for users of their services that pervaded the financial system in the run-up to the Great Recession. For the limited, approximately 15-20 financially and systematically important DCOs then, compliance with risk management rules and maintaining the strictness of their application to DCO clients is a subject of appropriate reporting and review.
See
https://www.fdic.gov/bank/analytical/CFR/2012/wp2012/CFR_WP_2012_01.pdf
The Supply-Side Determinants of Loan Contract Strictness, FDIC Working Paper No. 2012-01, for a description in another, but analogous context, for discussion of how views of the need for strict application of requirements to transactional partners or users are arrived at by financial institutions. As noted at the outset, banks write tighter contracts when they suffer defaults to their own portfolios. This suggests that lenders use their default experience to make inference about their screening ability and adjusting contracts accordingly. In the DCO context, the analogous situation might be, competitive DCOs lifting or lightening their counter-party or client credit-worthiness or financial stability requirements if there had been an extended period without, or with a lower level, of defaults. Such a competitive approach to enforcement might be useful within a market context, but might build in unanticipated risks. As Captain Sullenberger has often pointed out, selective compliance is a source of many accidents and unneeded risks.
Therefore the CFTC reporting on risk management compliance by DCOs appears to be valid, well justified, and consistent with the overall approach of Dodd-Frank to remove the potential sources of financial instability which created the financial crisis of 2007-2008.
Information about compliance with risk management requirements by Derivatives Clearing Organizations (DCOs) which are systematically important is essential as another bulwark against cascading financial systems failures of the type which lead to the financial system stress of 2007-2008 and the demise of several institutions caught up in counter-party risk and unanticipated losses from such risks. The requirement that derivatives be cleared through organizations, to give transparency and reliability to derivatives valuation, liquidity, and risk management is an essential link in the reasonable regulation of the role of derivatives in modern financial systems. In addition, because DCOs are essentially markets providing financial services to derivatives originators and holders, they are in a competitive position with regard to other DCOs and therefore subject to the same types of incentives for weakening, or cheapening, controls and costs for users of their services that pervaded the financial system in the run-up to the Great Recession. For the limited, approximately 15-20 financially and systematically important DCOs then, compliance with risk management rules and maintaining the strictness of their application to DCO clients is a subject of appropriate reporting and review.
See
https://www.fdic.gov/bank/analytical/CFR/2012/wp2012/CFR_WP_2012_01.pdf
The Supply-Side Determinants of Loan Contract Strictness, FDIC Working Paper No. 2012-01, for a description in another, but analogous context, for discussion of how views of the need for strict application of requirements to transactional partners or users are arrived at by financial institutions. As noted at the outset, banks write tighter contracts when they suffer defaults to their own portfolios. This suggests that lenders use their default experience to make inference about their screening ability and adjusting contracts accordingly. In the DCO context, the analogous situation might be, competitive DCOs lifting or lightening their counter-party or client credit-worthiness or financial stability requirements if there had been an extended period without, or with a lower level, of defaults. Such a competitive approach to enforcement might be useful within a market context, but might build in unanticipated risks. As Captain Sullenberger has often pointed out, selective compliance is a source of many accidents and unneeded risks.
Therefore the CFTC reporting on risk management compliance by DCOs appears to be valid, well justified, and consistent with the overall approach of Dodd-Frank to remove the potential sources of financial instability which created the financial crisis of 2007-2008.
