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Financial Economists Roundtable Emphasizes Importance
Of Liquid Derivatives for Domestic and World Markets
Committee Chaired by Tepper School of Business Professor Chester Spatt
Makes Recommendations for Central Clearinghouses and Derivatives Trading
PITTSBURGH—Restrictions on Wall Street's ability to trade in derivative securities, by legislation or regulation, could substantially reduce liquidity in the market and drive up costs to end users, according to a statement issued today by a Financial Economists Roundtable (FER) committee, chaired by Chester Spatt, the Pamela R. and Kenneth B. Dunn Professor of Finance and director of the Center for Financial Markets at the Tepper School of Business at Carnegie Mellon University. In addition, the statement, which has received the endorsement of many prominent financial economists, supports efforts to increase transparency, assure more accurate pricing, and encourage the migration of derivatives trading to clearinghouses and exchanges through the use of capital requirements.
"This policy statement makes clear the importance of derivative securities and their liquidity to the market, especially in terms of helping to share risks," Spatt said. "While we favor greater incentives to encourage the use of central clearinghouses, we also recognize the importance of customized transactions that may not be suitable for central clearing. Of course, we need to continue to encourage innovation in over-the-counter derivatives markets."
The statement makes several important recommendations relating to derivatives trading, including:
- Recommending incentives for the migration of more derivatives transactions to central-clearing facilities by offering more favorable capital requirements without requiring all transactions to be centrally cleared;
- Recommending improved criteria for the collateralization of positions that do not reflect standardized derivatives;
- Supporting the use of data repository requirements, including unfettered supervisory access by regulators and sufficient information to understand systemic risk exposures in the financial system;
- Encouraging post-trade price transparency for all sufficiently standardized over-the-counter products.
- Supporting the migration of trading in actively traded products to exchanges;
- Supporting regulations against market manipulation, while opposing potential regulations on speculative trading, such as on holding "naked" credit default swaps.
The statement was prepared by a FER committee consisting of Spatt, Darrell Duffie, the Sean Witter Distinguished Professor of Finance at the Graduate School of Business at Stanford University, and Albert S. (Pete) Kyle, the Charles E. Smith Chair Professor of Finance at the University of Maryland's Robert H. Smith School of Business.
"Although we advocate incentives to promote greater use of central clearinghouses, they should not be regarded as a panacea," Spatt added. "Central clearinghouses need to be closely supervised as they tend to concentrate risks, which could be a point of vulnerability in the event of a future financial crisis."
The full statement can be accessed at http://www.tepper.cmu.edu/news-multimedia/news/fer-reforming-the-otc-derivatives-markets/index.aspx.