Fed says central OTC clearing would curb market risk

WASHINGTON (Reuters) - Centralized clearing of over-the-counter derivatives would help to reduce the risk that these instruments pose to the wider financial system, a senior Federal Reserve official said on Monday.
Patricia White, associate director of research and statistics at the Federal Reserve, said in testimony prepared for the Senate that OTC derivatives had amplified shocks during the financial crisis, which resulted in the failure of investment bank Lehman Brothers in September.
"The Board believes that moving toward centralized clearing for most or all standardized OTC products would have significant benefits," she told the Senate Subcommittee on Securities, Insurance and Investment.
Regulators have been working to limit the risks of spillover from problems in one market to the wider system. The spillover made matters much worse during the current financial crisis and the White House has proposed a sweeping overhaul of the U.S. regulatory structure.
These plans, which are being intensely debated by Congress, include making the Fed a systemic regulator for all firms, payments and clearing systems whose failure could endanger the broader financial system.
White said one promising route to achieve the centralized clearing of OTC products was via establishing central counterparties. Several already exist, and regulators here and abroad are trying to speed up the creation of new entities to embrace a broader range of OTC products, she said.
Such steps will require the development of electronic systems to feed trade data to new central counterparties and better back-office processes to speed up trade confirmation.
But White said the Fed did not think that all OTC products should be centrally cleared, and she said it was important to retain flexibility for nonstandard OTC instruments, although these should also be subject to greater scrutiny.
"A flexible approach that addresses systemic risk with respect to standardized and non-standardized OTC derivatives, albeit in different ways, is most likely to preserve the benefits of these products," she said.
(Reporting by Alister Bull, Editing by Kenneth Barry)

Source: Reuters