Harmony on OTC

Terry Flanagan

Regulators seek common ground on swaps clearing, execution, and reporting.

International regulators are working to establish standards for the execution, clearing, and reporting of OTC derivatives transactions, which they acknowledge to be a moving target, as laws are being passed on the national and international levels.

In the United States, the Dodd-Frank Act requires the SEC and CFTC to hammer out rules on swaps, while in Europe, that task will be delegated to the European Securities and Markets Authority once legislative mandates (e.g., MiFID and EMIR) get finalized.

“There is a broad degree of commonality, including improved transparency, formalization of position limits, and an appetite to centrally clear and report OTC derivatives,” Dr. Anthony Kirby, director of the regulatory reform and risk management practice at Ernst & Young in London, told Markets Media. “There are also emerging differences which need to be addressed in order to reduce the potential for regulatory arbitrage.”

In a joint report to Congress, the SEC and CFTC have detailed their efforts to work with their international counterparts to achieve harmonization and resolve extraterritorial issues related to OTC.

The report also provides an overview of differences between the legislation being crafted around the world.

In the wake of the global financial crisis, the G20 in 2009 resolved to have OTC reforms in place by the end of 2012.

To date, the United States and Japan are the only jurisdictions that have adopted legislation mandating central clearing of standardized OTC derivatives.

The Council of the European Union has agreed on a text of European Market Infrastructure Regulation (EMIR) that will guarantee open access to clearinghouses for OTC derivatives, while ensuring that clearinghouses have unfettered access to data feeds from execution venues.

As part of the legislative procedure, the EU Council, European Parliament and European Commission are negotiating to resolve differences and to finalize EMIR, which is expected in 2012. After EMIR is approved, ESMA will have primary responsibility for implementation.

The European Commission has published draft proposals for a revised directive (MiFID II) as well as a regulation (MiFIR).

Provisions related to OTC derivatives are addressed primarily within MiFIR, such as mandatory execution of trades on trading venues, reporting of trading activity, and removing barriers between trading venues and providers of clearing services.

The joint SEC/CFTC report notes differences between FinReg and MiFID/MiFIR/EMIR on clearing, reporting, and execution.

For example, on the issue of protection of collateral for cleared swaps, the CFTC has adopted a segregation model that provides for legal segregation with operational commingling. Under this model, FCMs and clearinghouses would be permitted to operationally commingle collateral but to account for such collateral individually.

In Europe, the EU Council version of EMIR requires a CCP to offer clearing customers a choice between individual client segregation and omnibus segregation for both listed and OTC swaps. However, the European Parliament version of EMIR requires full segregation of customer assets. Until EMIR is finalized, an assessment on consistency cannot be provided, the report said.

Efforts to achieve harmonization at the regulatory level are proceeding apace, according to the joint report to Congress.

The SEC and CFTC are working on a project of the International Organization of Securities Commissions (IOSCO) to coordinate central clearing requirements for counterparties to OTC transactions, and on a project of the Committee on Payment and Settlement Systems (CPSS) and IOSCO on principles for financial market infrastructures, including CCPs and trade repositories.

The SEC and CFTC are also engaged in bilateral discussions with regulatory counterparts in the EU, Japan, Hong Kong, Singapore and Canada.

Hong Kong is on track to launch an OTC derivatives clearing system by mid-2012.

Hong Kong Exchanges and Clearing Ltd. (HKEx) has established two new departments, the OTC Clearing Operations Department and the OTC Clearing Risk Management Department, to be responsible for the OTC clearing business.

HKEx completed the platform selection process and commenced implementation work in November 2011.

In Canada, the Canadian Securities Administrators (CSA) has released a timetable of public consultations related to derivatives reforms, which calls for seven publications over the next two months, to go along with the two that were published in 2011.




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