Responding to the challenge of OTC market reforms

The OTC derivatives market is currently in the midst of sweeping regulatory reforms as the impact of the Dodd Frank Act and Basel III commitments take affect. As part of this reform, Australian banks and offshore subsidiaries of major overseas banks will be required to settle most derivative products through clearing houses or via a central clearing party.

However, it is unlikely a domestic clearing house will emerge anytime soon, which means Australian banks will need to settle through an overseas bank that acts as a central clearing party.

The implications and challenges of OTC reform…

  • Margin compression - fees paid to overseas clearing houses will reduce profitability as well as the effects of standardisation and price transparency
  • Less liquidity - cleared transactions are likely to consume more liquidity due to margin requirements
  • Increased demands on operations and technologies - as market infrastructure evolves and different market participants and intermediaries become involved in what were once bi-lateral trades
  • Impact on bank's capital requirements and product mix - as a result of non-cleared derivatives becoming more capital intensive
  • Evolution of new services - customers will be looking to banks to provide new services required for new market requirements.
Conversely, cleared trades will benefit Australian banks in terms of the capital required, which will be the case particularly under Basel III.

Getting the response to OTC reform right…

For Australian banks it is a time to maintain a watching brief as the regulatory development and rollout continues; identifying the response required for continued participation in the derivatives market concurrent with formulating a longer-term strategy.

While a ensuring minimum compliance at this stage is an option, a strategic opportunity exists to workout the optimum product mix between cleared, collateralised but uncleared and uncollateralised derivatives from a capital and market strategy perspective.

And we can help…

In meeting the challenges of OTC reform head on; bringing to our clients an understanding of how one set of regulatory reform such as Dodd Frank intersects with Basel III as well as other emerging reform nuances such as new derivative pricing themes.

OTC market reform and PwC: want to know more?

Read more on how PwC is helping clients adapt to regulation reform and a more in-depth analysis on how regulatory developments will impact market.

Background - G20, Dodd-Frank and the EU response

Why the focus on the OTC derivatives market?

It has been argued that the OTC derivatives were a major contributor to the Global Financial crisis leading to a drive for reform centred around increased standardisation, greater use of central clearing and increased capital requirements. The Dodd-Frank Act in the US and the commitments made by the G-20 members have been shaping these reforms.

G-20 commitments

The G-20 leaders agreed that:
  • All derivatives should be traded on electronic platforms and cleared through central counter parties by the end of 2012.
  • All OTC derivatives should be reported to trade repositories.
  • Derivatives not centrally cleared should be subject to higher capital charges and enhanced risk management practices.
Following the G-20 commitments, the Financial Stability Board released a report containing 21 recommendations aimed at addressing the practical challenges of moving towards OTC reform. The recommendations highlighted the practical challenges faced in implementing reforms in the key areas of standardisation clearing, electronic trading and reporting.


The Dodd-Frank Wall Street Reform and Consumer Protection Act is a wide-ranging package of reforms, consistent with the G-20 commitments, that represent the US legislative's response to the global financial crisis.

The US are furthest ahead in the development of the rules required to implement the reforms, but the sheer volume of rules required are evinced by the fact that key bodies charged with this process, the Commodities Futures Trading Commission and the Securities Exchange Commission, have announced 6 month delays to allow time to complete the rule-making process.


In 2010 the European Union published a set of proposed regulations on OTC derivatives and market infrastructure. The European Market Infrastructure Regulation proposals cover requirements for derivative market transactions, central counter-parties and trade repositories with a view to the implementation of the G-20 objectives.

The challenge of global consistency
The challenge of global consistency has become apparent as world regulators wrestle with the rule-making process. Three important goals have emerged, as noted in the recent US congressional hearings on derivatives market reform:
  • Global regulations should avoid the emergence of opportunities for regulatory arbitrage
  • Market disruption must be avoided
  • Incentives for off shoring must be eliminated.
While these goals are commendable and even critical to the ongoing operation of orderly efficient markets, the practical challenges in achieving them are considerable.