Reuters | June 5, 2011
By Huw Jones

LONDON, June 5 (Reuters) - The world's top 14 derivatives dealers may need extra cash to handle a surge in transaction clearing, especially in choppy markets, the Bank for International Settlements (BIS) said.

Clearing is being favoured by regulators because it is backed by a default fund that ensures a trade is completed even if one side goes bust, as with the collapse of Lehman Brothers during the financial crisis.

World leaders have agreed that chunks of the $600 trillion off-exchange derivatives market must be standardised and cleared by the end of 2012 to broaden transparency and curb risk.

Researchers at the BIS, a global forum for central bankers, looked at whether the "Group of 14" dealers (G14) that dominate derivatives trading would have enough capital to handle the anticipated surge in trades that will have to be cleared.

BIS concluded in a paper published on Sunday that "it seems unlikely that G14 dealers would have much difficulty finding sufficient collateral to post as initial margin".

"By contrast, dealers may need to increase the liquidity of their assets as central clearing is extended," BIS said.

Central clearing covers about half of $400 trillion in interest rate swaps, 20-30 percent of the $2.5 trillion commodities derivatives, and about 10 percent of $30 trillion in credit default swaps.

The G14 dealers comprise Bank of America-Merrill Lynch, Barclays Capital, BNP Paribas, Citi, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JP Morgan, Morgan Stanley, RBS, Societe Generale, UBS and Wells Fargo Bank.

BIS said they could face a cash shortfall in very volatile markets when daily margins are increased, triggering demands for several billions of dollars to be paid within a day.
"These margin calls could represent as much as 13 percent of a G14 dealer's current holdings of cash and cash equivalents in the case of interest rate swaps," BIS said.

Clearing operators like ICE, CME, LCH.Clearnet and Eurex are vying to capture the huge increase in clearing volumes expected but policymakers are taking steps to make sure operators remain robust.

Requiring clearing houses to be able to withstand a default by two major clearing members could also help financial stability, BIS said. Current rules require clearers to be able to ride a single member default.

Clearers could also benefit from adjusting initial margins to market volatility levels or set them according to the highest level of volatility, BIS said.

A more streamlined clearing sector would allow for multilateral netting across different types of derivatives to ease the burden of margining, it added. Linking clearers, known as interoperability, would also bring netting benefits.

The European Union is set to effectively bar interoperability among derivatives clearers for at least three years, believing it creates contagion risk.

(Editing by Erica Billingham)