Regulation of over-the-counter derivatives

Background

Over-the-counter (OTC) derivatives are financial contracts negotiated privately between two parties, rather than traded on an exchange. A party might choose an OTC derivative instead of an exchange-traded one if it needs customisation, precision, or market access that an exchange contract cannot provide.

In the aftermath of the 2008 financial crisis it was found that OTC derivatives had played an amplifying role: magnifying risk, hiding leverage and transmitting losses across the financial system in ways regulators and market participants did not fully understand. Because OTC derivatives then tended to be uncleared and the largest swap dealers often did not provide margin, if one party failed, the other might suffer sudden losses—with no central clearinghouse or margin to absorb shocks. In response, a range of regulatory measures were introduced, including:

1. •

   central clearing for standardised derivatives entered into by large swap market participants

2. •

   Trade Repositories (TRs) for transparency

3. •

   margin requirements for non-cleared OTC derivatives entered into by large swap market participants