Saturday, November 3, 2012

Clearing Derivatives in the post EMIR Era – “Driving in Safeland will become complicated!”

Assume you are living in Safeland. Safeland is a developed country. Today, it has one major problem: Out of 100,000 inhabitants, 40 people die, on a yearly average, in car accidents (Systemic Risk). This rate compares to 2009 figures of countries like Afghanistan, Egypt, and Eritrea.

Safeland's government (G 20, European Union, ESMA, and Bank for International Settlements) decide to limit the danger inherent in driving a car (Derivative) in Safeland.

To win the battle, the government suggests drastic measures:

  • Professional drivers (Financial Counterparties) are no more allowed to drive their own car. Instead, every time they would like to drive, they must lend their car at a national agency (Central Counterparty – CCP). This agency will only borrow you a car if you deposit some guarantee for lending it (Collateral). In addition, you cannot drive as long as you want and where you want. Predefined arrangements are offered which specify the lending conditions (ESMA Classified Derivative).
  • Non-professional drivers (Non-Financial Counterparties) participate much less in Safeland's car traffic. They are, therefore, considered less dangerous (systemic) and can still buy and drive their own car. Obviously, the government intends to further specify what a non-professional driver is. The idea is to monitor closely the distance that each individual is driving over specified time periods (Clearing Threshold). However, non-professional drivers must deposit, in addition to the selling price, a guarantee (Collateral) with their car vendor (OTC Counterparty). What's more, non-professional drivers are not only obliged to prepare properly for each trip (Risk Management Techniques) but also to pass regular health checks and to adapt their initial guarantee deposit if necessary (Mark to market / Mark to model). Finally, they will have to fill out surveys on a monthly basis and report any anomaly they have encountered during a trip (Reporting Obligation to the Competent Authority).

As you can imagine, Safeland's professional drivers are not happy. They argue that the proposal is improper. After all, they are professionals and know how to drive cars. “This makes sense.” says Safeland's prime minister on national television and grants several concessions:

  • First, if a car can only speed up to 50 km/h (Structured Derivative Transaction / Not ESMA Classified Derivative), even professional drivers can still own it by themselves.
  • Second, drivers employed by Safeland's government and other public entities are not subject to limitations. Obviously, the state of Safeland is expected to have enough cash to fix a problem, if any.
  • Finally, on private roads, professional drivers can do whatever they like (Intragroup Transactions).

What about Safeland's tourists?” – asks Peter, a lobbyist for Safeland's tourist industry, who doesn't want his name to appear on this blog – “Can they still visit our beautiful country, bringing their own car?” The short answer of Safeland's government is “No, they will be treated as if they were Safeland citizens.”

Let me finish with a final notice to any Safeland citizens who already own a car today: Don't worry, you can keep it in the future. Hopefully, you have recently bought a new car....