06.07.2012
By Terry Flanagan

Iosco Issues Standards To Regulate Derivatives Markets

Securities regulators have issued a set of standards by which providers of derivatives services, such as banks and other intermediaries, will be subject to clearing, reporting and capital adequacy requirements.

The standards, issued by the International Organization of Securities Commissions (Iosco), are intended to address derivatives market intermediary obligations that should help mitigate systemic risk, requirements to manage counterparty risk in the OTC markets and also protect market participants from unfair or fraudulent business practices.

“The final structure of the derivatives, bonds and commodities information industry is a key unknown in centralizing counterparty risk in the post Dodd-Frank era,” said Ron D’Vari, chief executive of financial advisory firm NewOak Capital Advisors.

“Transparency, connectivity and risk management are key in the new world under tighter US and European regulatory regimes. A centralized market requires a facilitator, yet the new regulations let the market decide. So, the question is who will be the middleman without conflict?”

Historically, derivatives market intermediaries (DMIs) have often not been subject to the same level of regulation as participants in the traditional securities market. Without sufficient regulation, some DMIs operated in a manner that created risks to the global economy that manifested during the financial crisis of 2008.

Firms will require extensive upgrades in systems, policies and procedures as a result of Dodd-Frank, MiFID II, Emir and other derivatives legislation enacted in the wake of the global financial meltdown.

“Swap dealers and major market players certainly face a considerable compliance burden going forward and changes across systems, policies procedures, as well as pre- and post-trade work flow are likely warranted,” said Sam Peterson, senior advisor at Chatham Financial, a risk advisor.

“This will be a monumental challenge, especially for the tier two and smaller players that may not have the staff or resources available, or systems in place, to adapt easily.”

The Iosco standards follow on the commitment by G20 leaders in 2009 to reform the OTC derivatives market in response to the global financial crisis, taking into account distinctions between the OTC derivatives market and the traditional securities markets, and the differences in jurisdictional approaches of international market authorities.

Iosco created a task force on OTC derivatives regulation in 2010 to co-ordinate securities and futures regulators’ efforts in development of supervisory and oversight structures related to OTC derivatives.

Previous reports by the Iosco task force have focused on execution, clearing and reporting requirements.

“The goal is to reach transparent and efficient financial markets to avoid another financial crisis,” said D’Vari at NewOak Capital Advisors. “As the market structure evolves, the infrastructure is essential to legally verify reference-entity, reference-obligation data and the terms and counterparties to allow trades to be executed, confirmed and tracked.”

Financial end users must prepare—and non-financial end users may elect—to execute trades on trading platforms, or work with firms that have access to these platforms.

Trades will need to be confirmed post-trade much more quickly and portfolios will need to undergo period reconciliation and, in some cases, compression.

“Financial end users must prepare for central clearing and some may face bilateral margin requirements for the first time, both of which require new documentation and, with respect to clearing, a substantial amount of leg work in getting set up,” said Peterson at Chatham Financial.

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