How Federal Reserve wants to reform OTC clearing

A senior Federal Reserve official said that centralized clearing of over-the-counter derivatives would help to reduce the risk that these instruments pose to the wider financial system. Increased shocks of OTC derivates during the financial crisis were mentioned by Patricia White, associate director of research and statistics at the Federal Reserve, who said that the failure of investment bank Lehman Brothers was caused by this.

Proposals of the White House and plans of regulators include making the Federal Reserve a universal regulator for all firms, payments and clearing systems whose failure could endanger the broader financial system.

Creation of new central counterparties to assist the existing foreign and local entities has been stated as the way of attaining the centralized clearing of OTC products by White. However, she said that Federal Reserve was not intending to clear centrally all OTC products, but retain flexibility for nonstandard OTC instruments. Further White added that these nonstandard OTC instruments should be subject to greater scrutiny.

Such steps will necessitate the development of electronic systems to feed trade data to new central counterparties and better back-office processes to speed up trade confirmation.