While global regulatory initiatives were designed to bring greater stability to the financial system, certain provisions have the potential to create unintended consequences – including a global liquidity crunch.
According to some estimates, requirements for the mandatory central clearing of derivatives contracts could create a need for additional collateral of between $1 and $2 trillion in USD equivalents globally. To meet these requirements, funding markets would need to increase around 50% in size – an unrealistic likelihood as liquidity remains tight.
This potential liquidity shortage is exacerbated
by the limited acceptable collateral
for clearinghouses. For example, variation
margin will require cash to be posted in
the traded currency while initial margin will
consist largely of G7 sovereign debt. The
two highest quality types of collateral will
be removed from the market to facilitate
clearing as new clearing participants historically
have not maintained these assets.
Download the Congressional Testimony: The unintended consequences of new regulations