However, the process is fragile because there are pressures to shape the standards in a way that puts the least burden on the domestic banks and financial infrastructures in one country relative to the institutions in other countries. There is understandable and genuine concern that the impact of moving to global standards will fall disproportionately on some types of firms. In my view, the way to mitigate these issues is to have a long phase-in period in the transition to the new standards rather than to soften or alter the standards to shelter those firms that happen – perhaps by historical accident – to be starting in a less advantageous position. The focus should be more on the side of all ending up in a similar place, rather than on the relative degree of difficulty in getting there. The process is also fragile because some countries seem intent on strengthening their own set of standards before the international process has had a chance to reach consensus. Although it is understandable that countries would want to move quickly to strengthen their regulatory regimes, such actions should not be undertaken in a way that is immutable and unresponsive to the emerging international consensus. 1 At the end of the day, to achieve harmonized standards, each sovereign nation is going to have to bend a little bit from what it believes is best for its financial system viewed in isolation.
However, I suspect that these efforts will not fully succeed without measures to develop marketplaces and infrastructures that promote greater transparency for all OTC derivatives activity, including more and higher-quality information on prices and transaction volumes. OTC derivatives dealers have natural incentives to favor opaque, decentralized markets that preserve their information advantage relative to other participants. The greater profit margins that derive from this advantage create incentives to favor more bespoke OTC derivatives over more standardized OTC instruments. Making more and better pricing information available to a wider range of market participants will increase competition and lessen the profit incentives that stem primarily from the opacity of these instruments and markets. Improving transparency should make the benefits that stem from standardization such as increased liquidity, reduced transaction costs, and lower counterparty risks more dominant, helping push the evolution of the OTC derivatives market in the direction of greater standardization and homogeneity. This doesn’t mean that bespoke products will vanish. They will continue to exist. But they will exist primarily because they better serve the needs of the OTC derivatives customer, not because they create an informational asymmetry that allows rents to accrue to the securities dealer. Greater transparency would also have other benefits. If regulators had ready access to current OTC derivatives transaction information in trade repositories, I suspect that this would serve as a brake on the use of OTC derivatives that are used for more questionable purposes. For example, this includes trades undertaken to evade accounting rules or to circumvent investment charter limitations.