Enhancing information disclosure to strengthen derivative counterparties
This article published by The Open Review of Management, Banking and Finance explores whether better information disclosure would improve outcomes for the counterparties of derivative transactions. Derivatives have two principal roles: hedging and speculation however the boundary between these elements can be indistinct and for the unwary a derivative trade can be dangerous exposing a counterparty to potentially unlimited losses and multiple risks. Derivatives play a significant role in the stability of the financial system as a whole. The growth of the derivatives market has led to the dispersion of risks through financial markets and when a crisis occurs this can lead to risk being rapidly transmitted and contagion. This article also considers a type of often non-disclosed risk, often known as Potential Future Exposure (PFE) or Credit Limit Utilisation (CLU) and argues that better disclosure may ameliorate the risks of derivatives and lead to improved outcomes for all counterparties. However this is likely to be resisted by banks who are the principal vendors of derivatives.