Systemic risk concerns prompt call for non-financial end users to stick to cleared deals.
The European Union’s systemic risk regulator has advised non-financial derivatives end users to avoid OTC transactions and use centrally cleared instruments, even if they are exempt from the requirement to do so.
The European Systemic Risk Board (ESRB), chaired by European Central Bank (ECB) boss Mario Draghi, said that there are both systemic and selfish reasons for using centrally cleared transactions. In reference to the selfish reasons for using cleared transactions, the ESRB said:
“From a macro-prudential stance, it is preferable that non-financial corporations clear their derivatives through CCPs by paying margins rather than obtaining similar services from banks in exchange for a fee. There is the risk that banking fees, which are essentially resources and which leave the non-financial corporations, will not adequately price the risk, from the point of view of both the banks and the non-financial corporations.”
From the perspective of systemic risk, the ESRB said:
“Derivatives held in the context of commercial and treasury financing activities are not risk-free because, in cases where they are not appropriately priced in, they may lead to an inefficiently large level of hedging, which may have systemic consequences.”
The ESRB gave its advice in a document issued this week, although dated July 31: Advice of the European Systemic Risk Board.* While the board’s recommendations are not binding, they are widely seen as indicative of the ECB’s views. The ESRB’s advice also carries weight with the European Securities and Markets Authority, which is drafting central clearing rules.