The Committee on Payment and Settlement Systems issued a report today, which concludes that, over the past few years, the clearing and settlement infrastructure of OTC derivatives markets has been significantly strengthened, but that further progress is needed in some areas.

The report focuses on the risks created by delays in documenting and confirming transactions; the implications of the rapidly expanding use of collateral to mitigate counterparty credit risks; the potential for expanding the use of central counterparty clearing to reduce counterparty risks; the implications of OTC derivatives prime brokerage; the risks associated with unauthorised novations of contracts; and the potential for significant market disruptions from the closeout of OTC derivatives transactions following the default of a large market participant.

Specifically, it calls for institutions to extend their efforts to reduce confirmation backlogs in credit derivatives to other OTC derivative products, using automated systems whenever possible. To mitigate the risks of remaining backlogs, more systematic use of economic affirmations is appropriate and over time dealers should work toward daily portfolio reconciliations with their most active counterparties, it says.

Also, it says market participants should identify steps to mitigate the potential market impact of replacing contracts following the closeout of one or more major participants.

In addition, as the market infrastructure moves further in the direction of centralised processing of trades and post-trade events, several issues will assume greater importance, the report indicates: providers of essential post-trade services for OTC derivatives should provide open access to their services and should aim to achieve convenient and efficient connectivity with other systems; and, central banks and supervisors will need to consider whether certain existing standards for securities settlement systems should be applied to providers of clearing and settlement services for OTC derivatives that are not already subject to those standards.

The report was prepared for the CPSS by a working group consisting of representatives of prudential supervisors of major derivatives dealers as well as representatives of the central banks that are CPSS members. The Basel Committee on Banking Supervision had an observer on the group. The working group was chaired by Patrick Parkinson of the Board of Governors of the Federal Reserve System.