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Basel III Leverage Ratio Could Undermine Efforts to Address Systemic Risk in Derivatives Markets 

January 18, 2016

Skadden Arps Slate Meagher & Flom LLP, Lexology

Following the 2008 financial crisis, regulators across the globe have pondered how to ameliorate systemic risk in derivatives markets. At the 2009 G-20 summit, international regulators committed to address this risk through clearing and capital requirements for market participants. The implementation of a particular capital requirement known as the Basel III leverage ratio, however, may undermine derivatives clearing for clients of clearing firms that are banks subject to the leverage ratio (Clearing Firms). Coordinated regulatory intervention will be required to ensure the leverage ratio does not compromise derivatives clearing and the overarching objective of reducing systemic risk.

The Dodd-Frank Act implemented the G-20 commitment to clearing by requiring the clearing of certain standardized swaps through a regulated central counterparty or clearinghouse (CCP). The Commodity Futures Trading Commission (CFTC) has implemented the Dodd-Frank mandate by requiring most interest rate swaps and credit default index swaps to be cleared. In order to avoid counterparty credit risk, market participants also have elected increasingly to clear less-standardized swaps and other swaps that the CFTC has not required to be cleared. Today, about 75 percent of transactions in the markets that the CFTC oversees (which also include futures markets) are centrally cleared — an exponential increase from about 15 percent as of the end of 2007, according to testimony from CFTC Chairman Timothy G. Massad before a Senate committee in May 2015. Read more

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