Where is all the collateral going to come from?

As we move towards a scenario in which central clearing of standardized OTC derivatives becomes the norm in markets across the globe, there is one question that is on the lips of a number of practitioners in these markets. And that is, "where is all this collateral going to come from?". The collateral and margin requirements across the various markets mean that there would be a requirement for vast amounts of (relatively) good quality collateral. The OTC market is many times the size of its exchange-traded counterpart, hence we are talking about a gigantic exercise involving trillions of dollars. What makes things worse is that the clearing houses and CCPs are not expected to provide much interest on the collateral provided to them. In effect, we are looking at a situation in which funds and securities that might otherwise have been used for trading will go out of the system. In a recent event that this author attended, the consensus was that the volumes traded in not just the OTC derivatives market but also other asset classes such as fixed income would dip sharply. It would become quite difficult for the market participants, especially the smaller firms, to sustain themselves in such an environment. Our hope is that in enforcing these changes we do not throw the baby out with the bath water.