Off the Reservation
Patrick Pearson is head of market infrastructure for the EC’s financial market regulator. He apparently hasn’t read the memo declaring that clearing mandates will usher in the era of the Big Rock Candy Mountain:
Central clearing . . . is a concept so dear to regulators [sic] hearts that it has become something of a mantra — particularly since the demise of Lehman Brothers and the counterparty risks that were brutally revealed by that event. So when Patrick Pearson . . . stood up to address an ABS conference in London on June 15 his words took some in the audience by surprise. “Clearing houses don’t reduce counterparty risk,” he stated. “They simply redistribute it. Central counterparties (CCPs) can act as a channel for risk. Their failure s far more dangerous than the failure of one single counterparty.”
. . . .
“If we shift massive amounts of OTC derivatives onto an exchange–are they safe enough to manage the risk? . . . . We don’t know. There are 13 clearing houses in Europe. If one defaulted there would likely be multiple defaults of clearing houses across the region. Just imagine how the markets would react.”
Hallelujah. How long have I been waiting for a regulator or legislator recognize those basic facts.
The author of this piece, Louise Bowman, recognizes that Pearson has gone off the happy talk reservation and committed the dire sin of telling the truth:
Hang on! The market has long worked on the assumption that central counterparty clearing will be mandated in Europe — it is just a matter of when . . . . The question is therefore what the highly eloquent Pearson was trying to say. In addition to questioning whether central clearing reduces counterparty risk he suggested that exchange trading of OTC derivatives might not be adopted in Europe–something that has also been seen as almost inevitable given the regulators’ drive for transparency in this market.
It is encouraging that not everyone in a position of regulatory responsibility has drunk deep the Klearing KoolAid. It will be interesting to see how things develop in Europe. It will be especially interesting to see whether an extended debate over clearing and exchange trading mandates lead to rather testy interactions between US and European officials, as alas, KoolAid seems to be the only thing served on Capitol Hill, Pennsylvania Avenue, and 21st St.
Pearson is, so far, pretty much a voice in the wilderness. One hopes, however, that he catalyzes a more constructive debate on these issues. There is a growing group of clearing skeptics among academics and practitioners. Pearson’s outspokeness raises the possibility that the skeptics’ arguments might actually receive a serious hearing at least somewhere it matters.
