Jeffrey Hogan Comments: U.K Backed Risk-Based Capital Charge - Derivate Week

Derivative Week, July 9, 2009

The U.K. Treasury backs calls for risk-determined capital charges for derivatives that cannot be centrally cleared. In a report today it also revealed it supports U.S. and European Union efforts to require those trades to be reported to a central repository.

A spokesman declined to elaborate on what charges will be applied to specific derivatives, but said a sliding scale will be applied “dependant on their risk.” He added that the Treasury, as a representative of the government, is working with the E.U. on the issue in a bid to improve the way financial markets are regulated. Both the E.U. Commission and the U.S. Treasury have released documents on the possibility of applying capital charges to bespoke derivatives that cannot be centrally cleared.

In the report, titled ‘Reforming Financial Markets', the department said it believes the trade repositories information should be made available to regulators to encourage transparency.

Jeff Hogan, head of business development at inter-dealer broker BGC Partners in London, said such an entity would assist regulators and supervisory bodies by making transparent the net positions per product of each clearing member, “so that exposures may be known and assessed prior to risk becoming untenable.”

Alex McDonald, ceo of the Wholesale Markets Brokers' Association in London, told Derivatives Week, “Capital charges on non-clearable derivatives is going to happen…In the end it could end up that capital charges could be cheaper than going onto a CCP. But there needs to be a move to have carve-outs, as such charges may have an adverse affect on firm's products and bilateral agreements.”

Hogan said riskier derivatives are defined as trades that do not display continuously observable prices, meaning that viable margins cannot be attached. “Clearing derivatives has nothing to do with the nature of the derivative itself, but rather the confidence of clearing members to put up their capital to assume counterparty risk and to be able to sell these derivatives into the market,” he said.

Also in the report, the Treasury said that investors, such as banks, who invest in structured products need to carry out more due diligence, and that they rely too much on rating agency assessments.

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