Accounting and regulatory issues
Products like an IRS are shown as off-balance sheet items as there is
an exchange of flows but no actual loan or deposit is made between
the two counterparties.
As far as profit-and-loss treatment is concerned the profit and loss
on trading should be realised immediately. The profit or loss on a
hedge should take place simultaneously with the profit or loss on the
item being hedged.
There are various accountancy standards around the world that
require banks to disclose information on interest rate risk, currency,
liquidity, maturity, information on fair values and the effects of hedge
accounting as described above.
The FSA has reporting requirements related to transactions includ-
ing options, and the European Union (EU) and Bank for International
Settlements have established guideline limits on risks, which each
bank may take. In turn the local regulator such as the FSA in the
United Kingdom will enforce these limits and may even make them
stronger.
SwapClear
The introduction of a central clearing counterparty facility for OTC
products including derivatives greatly helps to reduce the capital
adequacy requirements associated with OTC transactions. The LCH
launched SwapClear in September 1999 so that existing members
that meet the membership criteria for SwapClear can have their OTC
transaction cleared under the same principles used for exchange-
traded derivatives, i.e. variation margin, initial margin.
By having the OTC transaction cleared by LCH.Clearnet, an inde-
pendent third party, the requirement to put up capital to cover coun-
terparty risk is removed.
SwapClear went live in September 1999, initially clearing vanilla
swaps in G-4 currencies for up to 10 years’ maturity and in June 2002
extended the service to clear trades in G-4 currencies to a 30-year
maximum maturity as well as introducing the clearing of Swiss Franc
trades with a 10-year maximum maturity. In February 2003 the
service was extended once again to provide clearing facilities for com-
pounding and plain vanilla IRS with the following tenors:
• USD, EUR, JPY and GBP up to 30 years
• CHF, AUD, DKK, CAD and SEK up to 10 years
• HKD, NOK and NZD up to 5 years.
110 Clearing and settlement of derivatives
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