As a continuation of our five-part video series featuring John Hull, PhD and Alan White, PhD, FINCAD questioned the thought leaders on how regulation is affecting buy and sell-side organizations.
“Right now, regulations are changing things quite dramatically for buy and sell-sides. I think we are going to see more products going through central clearing parties (CCPs), which are really just like exchange clearing houses,” commented Hull. “If we recall prior to the crisis, it was common for variation margin to be posted, particularly when financial institutions were trading with each other. But initial margin was very rare. Now, however, it is becoming the norm. Both buy- and sell-sides are being forced to post more collateral in order to oil the wheels of the OTC market. This applies to financial institutions, hedge funds, insurance companies and pension plans—which are all lumped together under the regulations. While end-users are not directly affected, the regulations are such that financial institutions are trying to persuade their end-users to clear through CCPs, as this move will decrease their own capital requirements.”
White took a slightly different view on the use of CCPs. “On the positive side, using the clearing parties allows for netting that didn’t exist before. So, it’s not clear that the amount of collateral is indeed higher than it used to be in aggregate,” explained White. “It is true that for any one transaction, there is more collateral required. But because of the netting you get going through the CCPs, in my view, it evens things out.”
For more of Hull and White’s thoughts on the impact of regulation, check out the video.