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  1. 01 Purpose
  2. 02 Introduction
  3. 03 What is Exposure?
  4. 04 Why Does Exposure Matter?
  5. 05 Reducing Exposure
  6. 06 Why do regulators care?
  7. 07 What has been the regulatory response?


Before 2008 management of credit risk and exposure was at the discretion of market participants. Since 2008 regulators have created regulations requiring firms to carry out exposure reduction.

The belief is that these regulations will reduce systemic risk. In the case of Lehman Brothers this might (or might not) have made a difference.

This course does not cover cleared OTC trades but focuses on the uncleared market.

Systemic Risk

The capital markets are a globally inter-connected system which defies modelling even more than weather. Think of the interactions and linkages between the FX markets, bonds, equities and derivatives; directly or indirectly they all need each other to function normally.

Regulators learned from the Global Financial Crisis that risk in one market can have an effect in another. For instance, a default in OTC derivatives will require firms to sell off bonds held as collateral. If the effect of the default is to destabilise the bond market, then price volatility may mean the recovery value is below usual market levels, meaning losses for the surviving firms.

By requiring a direct connection between risk in OTC derivatives and holding Initial Margin (IM) to cover these, regulators aim to make the market self-balancing as risk-taking means placing more IM. This requires funding and ultimately should reflect back on the trader or desk taking the positions. Should a default occur, the IM assets should help offset losses.

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