Chapter 15

The Future Impact on Financial Markets

You should never make predictions, especially about the future.

Samuel Goldwyn (1879–1974)


The global financial crisis (GFC) that started in 2007 has had a major negative impact on financial markets and the economy in general. The GFC was blamed partly on OTC derivatives and their counterparty risks and opacity, neither of which was well controlled due to the historic light regulation of this market. A clear example of this is the bankruptcy of Lehman Brothers and the close out of the millions of OTC derivatives contracts traded by Lehman (many of which are still subject to legal wrangling several years later). It was therefore not surprising that much of the post-GFC regulatory reform has focused on OTC derivatives and, in particular, the mitigation of counterpary risk.

The most obvious way to make OTC derivative markets safer is to force banks to hold much larger amounts of capital against the counterparty risks they face. Indeed, Basel III capital rules first published in 2009 have done this via changes to the existing requirements, and the introduction of a new capital charge for credit value adjustment (CVA). This alone should make OTC derivatives safer and prevent banks from taking the kind of risks they did leading up to the GFC where many OTC derivative risks were backed by only very thin capital holdings. Higher capital charges may have been the only major change to OTC derivatives were it not for ...

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