Despite the important role they play in reducing systemic risks and their increasing popularity with market participants in recent years, post trade risk reduction services (PTRRS) continue to exist with “limited or no direct regulatory oversight”. With the intention to rectify this, the International Organization of Securities Commissions (IOSCO) recently published a consultation paper to identify potential policy considerations and propose sound practices as a guidance to IOSCO members and regulated users of PTRRS.
The consultation paper described PTRRS as services provided by third party providers to market participants “in order to assist them in reducing operational and counterparty credit risks associated with outstanding OTC derivatives trades”. The types of PTRRS covered by the report were mainly in portfolio compression and counterparty risk optimisation.
The increased use of PTRRS “present challenges for OTC market participants and merit further consideration from a risk perspective”. According to the report’s findings, risks include those associated with the market concentration of service providers, a lack of transparency regarding the algorithm used by providers, and a lack of meaningful due diligence by users of PTRRS.
The findings were used in IOSCO’s proposal for a number of sound practices. As an example, PTRRS users, as a part of due diligence, were recommended to “have a basic understanding of the design of the proprietary risk reduction algorithm(s) used by the service provider”, while providers should ensure that there is “appropriate transparency” around the algorithm used and proper controls and governance around it. IOSCO also recommended its members to observe “the implications of market concentration among PTRRS providers and whether market concentration results in any potential market risk”.
The deadline for sharing comments on the consultation is 1 April 2024.