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June 14, 2016

NetOTC – Third Time Lucky?

Is there still room for innovation in Banking?

You may have seen announcements about the status of the NetOTC business becoming similar to a phone call, "on hold" (see PR text below). The sentiment by regulators to introduce a new margin regime for any OTC contract outside of clearing, results in new regulations and new costs for all users of the OTC market. As you know over the next 5 years the introduction of regulations to require VM and IM will bring the biggest change in the OTC market since its inception. 

The new regulations are an answer to the question: "by what means can the risk between users of OTC contracts be reduced in the event of a default?"  Whether the bilateral margin regulations are the best answer to this is open to debate. The NetOTC team have played a complex game of inventing a different answer to this question in the form of their "Bilateral" service (see here) which involves an element of risk netting for IM purposes and a coordinated process for users in the event of a default.

The outcome of the "on hold" status indicates that their approach isn't accepted by regulators as either providing users compliance with the un-cleared margin regulations, nor worthy of special recognition as a valid method of reducing risk in the un-cleared OTC market.

And this is a disappointing outcome, as the brains behind NetOTC certainly thought through the details of how to design such a service, both legally, technically and operationally. What this makes me wonder is this: Is it now entirely up to regulators to design the structure of the OTC markets, even with consultation, and is innovation by users now a fruitless avenue? It isn't easy to get regulatory review of new processing services – needing considerable investment to demonstrate the details of a new idea.

I would really like to know from regulators why NetOTC isn't bringing a useful idea and explain the dialogue behind this outcome. Unlikely we'll get to hear that any time soon, which means for some time we must live with the new regulations from September.  Anyone else want to add flavour in the comments below?

Bill.

P.S. Third time lucky?

  1. The original service envisaged a multi-lateral service, no longer shown on the public website
  2. Current service "Bilateral" – now on hold
  3. Another try when regulators or regulations allow

London, New York – 9 June 2016 – NetOTC, the risk solutions firm that has been designing and building a full end-to-end market infrastructure for non-cleared OTC derivatives in close collaboration with regulatory and industry bodies, banks and their end customers, today announced that it had taken the decision to put its initiative on hold. 

Roger Liddell, CEO, NetOTC, stated:  "We developed the NetOTC pooled initial margin structure to make the use of collateral both more effective and more efficient. Core to our ambition was the objective to increase market safety and to protect against collateral exhaustion. To achieve this, we have worked with industry participants to create an end-to-end technology platform, a legal structure and a margin model, and we have been impressed by the appetite of the industry to engage and proud of the infrastructure model we have created.”

Roger Liddell, concluded: “For this September, however, the regulations do not currently allow for a more efficient use of collateral and do not envisage a pre-determined orderly default management process.  Both would have contributed substantially to regulators’ stated objective of sound, stable, resilient, transparent and orderly markets. I look forward to a more favourable regulatory environment in the future that will see NetOTC's market infrastructure solution reinvigorated."

And NetOTC will:

  • Complete the final stages of the technology build in order to leave the company in such a state that it can be revived when regulatory conditions allow.  As such NetOTC is invoking their plan to wind down the company with immediate effect.
  • Maintain a small team dedicated to completing the final stages of the technology build, including the final ISO information security certification.  They are focused on having a complete technology product available that can be reactivated when the rules allow.

For honesty purposes I must declare that I worked at NetOTC a while back, but not during the regulatory discussions on their most recent design, and I am subject to an NDA with them too.


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