Counterparty risk is driving industry change

Greater transparency in CDS pricing and the legitimisation of the product will certainly help dealing in foreign exchange swaps, where the counterparty risks involved have been magnified over this past year. The cost of hedging counterparty exposure is itself making dealing in the product cost-ineffective on an over-the-counter basis.

And there seems to be an increasing shift away from pricing and dealing towards credit, settlement and margining, otherwise incarnated in the form of a centrally cleared model for spot FX. This has been an area of much debate for several years and has seen the rise and fall of initiatives to take advantage of the supposed demand.

This might have something to do with the fact that the reasoning in the past was quite different from the basis of the need for this model now. In the past, the proposition centred on price transparency and levelling the playing field between the buy and sell side. Now it is quite simply elimination of counterparty risk. After all, the market will not grow unless traders are comfortable trading with each other.

Predictably, the only way this model will really take off is if the core dealers in spot FX have a stake in it. If that is not on offer, as was initially the case with the CME and Reuters joint venture, the liquidity buy-in will just not be there.

Saima Farooqi, Editor

Comments? please email saima.farooqi@incisivemedia.com