Derivatives Markets: The New Regulatory Paradigm
First published:
ISBN: 9781782722205
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Pricing
Pricing
Introduction
European Market Infrastructure Regulation
Dodd–Frank
Basel III
Solvency II
CCPs: Central Clearing of OTC Derivatives
Banks: The Impact of New Regulation
Asset Managers
Hedge Funds: Risk Management in an Illiquid World
Insurers: Liability-driven Investing for Insurers
Corporate Treasuries
Sovereigns
Other Sectors
Counterparty Risk Management
Collateral: Transformation & Optimisation
Liquidity
Pricing
Conclusion
Financial regulations are designed to change behaviour. They change what is permitted: in the US, proprietary trading is forbidden for banks and standard swaps must now be cleared. They change financial incentives – ie, prices and costs. Prices change market sizes. Costs change market participants, incentivising internal reorganisation and decisions on market entry or exit. If regulations did not change prices, costs and constraints, then they would be pointless.
This chapter will consider the effect of regulations on pricing. Regulations typically affect capital and funding, and fit into pricing as part of valuation adjustments (XVA) (Kenyon and Green, 2016a; Green, 2015; Lichters et al., 2015), see Table 17.1. We start by considering the effect of regulations on the fundamentals of quantitative finance, before covering the XVA machinery for credit, funding and capital costs. Following this look at pricing regulations, we examine consequences in the market and mitigants to regulatory costs. We give examples of secondary effects of regulatory costs: the effect of capital relief being priced into credit default swap (CDS) spreads; and how XVA costs move the exercise boundary for
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