The Financial Stability Board (FSB) has published its fifth progress report on the implementation of over-the-counter (OTC) derivatives market reforms, which will effectively force trades ‘on exchange’ by demanding central counterparty (CCP) clearinghouse involvement in most instances and a central repository be kept for all trades.
The latest six-monthly FSB report comes after the start of the enhanced OTC requirements under the US Dodd-Frank Act, with exceptions for corporate hedging, and ahead of the European Market Infrastructure Regulation (EMIR), which is due to start in Q1 2014. The fifth FSB update report takes stock of progress made by standard-setting bodies, national and regional authorities and market participants towards meeting the commitments made by G20 leaders at the Pittsburgh 2009 Summit that standardised OTC derivative contracts be traded on exchanges or electronic trading platforms, where appropriate, and cleared through CCPs, referencing the status of the US and European initiatives among others.
The G20 also insisted after the 2008 financial crash and collapse of Lehman Brothers that OTC derivative contracts should in future be reported to trade repositories, so that unwinding trades would be less difficult in the event of a further crash and that non-centrally cleared contracts be subject to higher capital requirements.
No jurisdiction had yet met the G20 commitments when the FSB begun its status research at the turn of the year, but the US has now forged ahead and the clock is ticking on European compliance. Less than half of the FSB member jurisdictions currently have legislative and regulatory frameworks in place, however, to implement the G20 commitments, notes the body, and there remains significant scope for increases in trade reporting, central clearing, and exchange and electronic platform trading in global OTC derivatives markets.
Progress in meeting the G20 commitments is expected to accelerate over the course of 2013, however, says the report as jurisdictions finalise legislative and regulatory frameworks and as specific requirements come into force – something that is already happening in the US and Europe as mentioned, but the FSB remains worried about elsewhere in the world.
The FSB chairman, Mark Carney, who is presently the Governor of the Bank of Canada but will take over that role at the Bank of England this summer, has written to all member jurisdictions requesting confirmation that legislation and regulation for reporting to trade repositories are in place, as well as their committed timetables to complete all OTC derivatives reforms. He stressed that the need for prompt action on trade reporting should not in any way diminish the need for rapid completion of reforms in other areas, such as central clearing, capital and margining, and trading on exchanges or electronic platforms.
Jurisdictions will need to resolve a number of outstanding policy issues over the course of this year, notes the FSB report, including:
- Uncertainties in the application of requirements in cross-border contexts: As jurisdictions are moving forward in implementing the new OTC rules and requirements, some cross-border potential conflicts, inconsistencies, duplication and gaps have emerged. This is not unexpected, given the complexity and novelty of the reforms being undertaken. With practical implementation of rules imminent across a number of jurisdictions, it is imperative that regulators work together to urgently address identified issues. As part of this, jurisdictions should promptly put forward their proposals for regulatory implementation, while preserving a sufficient degree of flexibility to allow for issues to be resolved without unnecessary market disruption.
- Trade reporting and data access: Jurisdictions should remove barriers to trade reporting by market participants, with particular attention to removing barriers to reporting of counterparty information and to information access by authorities.
- Central clearing and incentives: Jurisdictions relying in the first instance on incentives to drive central clearing of standardised OTC derivatives need to establish clear criteria and monitoring processes for determining how effective these incentives are in achieving the G20 commitment that all standardised derivatives be centrally cleared.
- Organised platform trading: Jurisdictions should also make progress on reforms to help move trading onto organised platforms. In the short term, they should enact legislation and regulation that would permit the imposition of trading requirements as appropriate.
Further international work should take place on the following, urged the FSB:
- Remaining issues around authorities’ access to trade repository data, such as data standards.
- The feasibility of a centralised or other mechanism to produce and share global aggregated data, taking into account legal and technical issues and the aggregated trade repository data that authorities need to fulfil their mandates and to monitor financial stability.
Looking forward, an increased focus will be needed on how effective jurisdictions’ reforms have been in meeting the underlying objectives of increasing transparency, mitigating systemic risk and minimising market abuse in a reformed OTC market. The risk of regulatory arbitrage, which would undermine the effectiveness of the reforms, is also identified by the FSB.
At the global level, the Bank for International Settlements (BIS), which runs the FSB secretariat from Switzerland, is also coordinating a macroeconomic impact assessment of the OTC derivatives regulatory reforms.
The FSB will publish a further progress report ahead of the G20 Leaders Summit in St Petersburg in September 2013. That report will update measures of progress in the use of centralised infrastructure, and will also provide an assessment of the state of readiness of market participants to further migrate towards the new infrastructure. The FSB will continue to monitor the extent to which the various OTC derivatives reforms meet the G20’s underlying goals of improving transparency in the derivatives markets, mitigating systemic risk, and protecting against market abuse.
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