The Regulation of Counterparty Risk in Over-the-Counter Derivatives Markets

Sean Campbell and Erik Heitfield

The events surrounding the collapse of AIG in September 2008 dramatically underscored the importance of effectively managing counterparty credit risk arising from over-the-counter (OTC) derivatives exposures. In this chapter we survey the actions undertaken by prudential supervisors, market regulators and authorities with mandates to safeguard financial stability, in conjunction with market participants, to mitigate counterparty risk though the use of central clearing for standardised OTC derivatives and robust margin standards for uncleared OTC derivatives. The first section briefly summarises commitments and associated legislative and regulatory actions by national regulators and international standards-setting bodies to coordinate and improve the regulation of OTC derivatives markets. The second section explains how central clearing can be used to reduce and manage counterparty risk and the third section summarises progress on transitioning derivatives markets from bilateral to central clearing. We then describe new international standards for margining of those derivatives that are not centrally cleared. Closely related to the market reforms discussed in this chapter are