02.29.2012
By Terry Flanagan

Regulatory Logjam

In an effort to ram through OTC reforms by the end of the year, regulators risk clogging up the system.

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.

“The fact is that there are genuinely too many moving parts,” David Holcombe, trading specialist at Rule Financial, a provider of business consultancy to global investment banks, told Markets Media. “Multiple regulatory bodies are casting regulation that impacts every aspect of the OTC flow, so the more rules that get hastily set and rushed in just to meet a political agenda, the more unintended consequences there will be.”

In the United States, which is considered to be six to 12 months ahead of other jurisdictions, as of February 1, 2012, a total of 225 Dodd-Frank rulemaking requirement deadlines have passed, according to Holcombe. Of these 225 passed deadlines, 164 (73%) have been missed and only 61 (27%) have been met with finalized rules.

“Global regulators are already struggling to keep to their own timelines, and my expectation is that they will still be many miles from completing all of the rule making mandated by the G20 by the end of this year,” said Holcombe.

In the United States, the Dodd-Frank Act requires the SEC and CFTC to hammer out rules on clearing, 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.

“A lot of positive change in line with G20 requirements will have been achieved by the end of this year so, clearly, politicians and regulators need to take stock at that point, and then cast a realistic plan for the future that considers the dramatically changed landscape, to avoid causing irrevocable damage,” Holcombe said.

The International Organization of Securities Commissions (IOSCO) on Wednesday published a report on requirements for mandatory clearing of OTC derivatives, a linchpin of the G20 financial reforms.

The report also recommends that national authorities communicate with each other on mandatory clearing regimes that are in place or proposed, including products subject to a mandatory clearing obligation, CCPs authorized to clear such products, and exemptions from a mandatory clearing obligation.

IOSCO’s report outlines recommendations that authorities should follow in establishing a mandatory clearing regime, including determination of whether a mandatory clearing obligation should apply to a product or set of products, consideration of potential exemptions to the mandatory clearing obligation, and consideration of cross-border issues in the application of a mandatory clearing obligation.

The report recommends that authorities implementing a mandatory clearing regime incorporate a bottom-up approach and a top-down approach in their decision-making process.

The bottom-up approach considers products that a CCP proposes or is authorized to clear. The top-down approach considers products that should be assessed for a mandatory clearing obligation, but where there may be no CCP clearing or seeking to clear that product.

Market forces, in the form of existing CCPs with bank clearing members, may force the hand of regulators, however.

“Banks are building and offering clients OTC clearing capabilities now, so a realist’s view is that the regulators will scale back ambition in order to rubber stamp the client clearing that has been built, and claim a pragmatic win on that, along with real wins such as reporting and repositories in all asset classes which will be finished and in place,” said Holcombe.

The report also recommends that national authorities communicate with each other on mandatory clearing regimes that are in place or proposed, including products subject to a mandatory clearing obligation, CCPs authorized to clear such products, and exemptions from a mandatory clearing obligation.

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