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OTC derivatives: Impacts of regulatory changes in the non-financial sector

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  • Araujo, Gustavo Silva
  • Leão, Sérgio

Abstract

In the aftermath of the 2007–2008 global financial crisis, a series of measures have been proposed to regulate the OTC derivatives market. The motivation is to increase the disclosure of OTC transactions aiming to decrease the probability of crisis. The main objective of this paper is to investigate how regulatory changes in the OTC derivatives market affect the non-financial sector. The Brazilian FX derivatives market provides a natural experiment for this issue: in 2011, the Brazilian government taxed short positions in FX derivatives to reduce the carry trade, which was causing the local currency to appreciate. Although Chamon and Garcia (2013, Capital control in Brazil: effective? International Monetary Fund, manuscript) find that this policy helped reduce the incentives for carry trade strategies, it could have unintended consequences on other markets. For example, if banks pass through the extra cost to clients, this taxation may affect the FX hedges of non-financial firms. This paper investigates whether, and if so how much, the increase in the cost of OTC derivatives is transferred to the non-financial sector. The results indicate that this cost more than doubled for companies exposed to devaluation of the local currency (for instance, importers). Although a thorough welfare analysis is beyond the scope of this paper, the findings suggest that this cost increase may be a concern to the extent that it could prevent EME firms from hedging their FX positions, as the NDF quotation of some EMEs is high due to the interest rate differentials.

Suggested Citation

  • Araujo, Gustavo Silva & Leão, Sérgio, 2016. "OTC derivatives: Impacts of regulatory changes in the non-financial sector," Journal of Financial Stability, Elsevier, vol. 25(C), pages 132-149.
    • Handle: RePEc:eee:finsta:v:25:y:2016:i:c:p:132-149
    DOI: 10.1016/j.jfs.2015.11.002
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    Cited by:

    1. Daisuke Miyakawa & Takemasa Oda & Taihei Sone, 2023. "Regulatory Reforms and Price Heterogeneity in an OTC Derivative Market," Bank of Japan Working Paper Series 23-E-12, Bank of Japan.
    2. Kristina Garskaite-Milvydiene & Raimonda Martinkute-Kauliene, 2021. "Examination of the Relationship between Derivative Financial Instruments and the Economic Development of Lithuania," Contemporary Economics, University of Economics and Human Sciences in Warsaw., vol. 15(2), April.
    3. Ospina-Forero, Luis & Granados, Oscar M., 2023. "A network analysis of the structure and dynamics of FX derivatives markets," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 615(C).
    4. Sérgio Leão & Rafael Schiozer & Raquel F. Oliveira & Gustavo Araujo, 2022. "Lending Relationships and Currency Hedging," Working Papers Series 565, Central Bank of Brazil, Research Department.

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    More about this item

    Keywords

    OTC markets; Capital controls; Carry trade; Capital flows; Cost of hedging;
    All these keywords.

    JEL classification:

    • F3 - International Economics - - International Finance
    • F38 - International Economics - - International Finance - - - International Financial Policy: Financial Transactions Tax; Capital Controls
    • G1 - Financial Economics - - General Financial Markets
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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