Regulatory Roadblocks on OTC Persist

Terry Flanagan

Efforts to develop a unified, global framework for market infrastructure are being hampered by competing regulations across jurisdictions, market participants say.

While global regulators seek to seek to adopt standards for critical financial market infrastructure such as CCPs and trade repositories, national and supranational legislation in the U.S. and Europe is being viewed as an obstruction.

“Regulators have been able to achieve high level agreements on clearing, trade reporting, electronic trading, and margin for uncleared trades, but the devil is in the details,” said Aaron Unterman, legal counsel—derivatives branch at the Ontario Securities Commission, during a panel discussion on Thursday. “We are seeing the beginnings of equivalency between the different regimes.”

Unterman noted that there existed “granular issues” associated with market infrastructure, and pointed to a report issued last year by the Intentional Organization of Securities Commissions (Iosco) and the Committee on Payment and Settlement Systems (CPSS), as an example.

The report enunciates principles designed to apply to all systemically important payment systems, central securities depositories, securities settlement systems, central counterparties and trade repositories (collectively “financial market infrastructures” or “FMIs”). “It was a very challenging document,” Unterman said.

While most principles in the report are applicable to all types of FMI, a few principles are only relevant to specific types of FMIs, such as Principle 7, which applies to liquidity risk.

Liquidity risk in Emir is based on covering the default of the two largest participants (“Cover Two”). The CFTC also uses the criterion of Cover Two for systemically important systems (non-systemically important systems need to comply with “Cover One”). CCPs that are active globally seek the same rules globally.

“Emir says Cover Two and CFTC says Cover One, except for systemically important financial institutions,” Milligan said. “Are those equivalent regimes for CCPs?”

With the first implementing measures of the European Market Infrastructure Regulation (Emir) coming into force, market participants are taking note of the significant degree of overlap between the Emir obligations and the provisions of the U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), which was passed in July 2010.

Both Emir and Dodd-Frank represent the implementation of the G-20′s commitment to improving risk management and reducing systemic risk in OTC derivative contracts.

“We are regulated by both the Bank of England and the CFTC, so there is no escaping Dodd-Frank and Emir,” said Susan Milligan, head of U.S. public affairs at LCH.Clearnet. “When there are conflicts, we will adopt the strictest interpretations with a view toward the goal of reducing systemic risk.”

Susan Milligan, LCH.Clearnet

Susan Milligan, LCH.Clearnet

LCH.Clearnet, the multinational clearing house, revealed recently that its U.S.-based entity LCH.Clearnet LLC has launched a U.S.-domiciled interest rate swap clearing service.

The service expands SwapClear’s interest rate swap offering and demonstrates the importance of the U.S. to LCH.Clearnet’s geographic expansion strategy.

In 2008, SwapClear had 20 direct clearing members, it’s now up to 83. At the beginning of the year, it was clearing 300 buy-side trades a day, it’s now up to 1,200 a day. Overall, it has over 400 buy-side clients who are clearing trades via clearing member firms.

“Hedge funds have been among the earliest adopters of central clearing,” Milligan said. “They are able to conduct more transactions with less risk because of central clearing.”

SwapClear clears more than 50% of all OTC interest rate swaps and more than 95% of the overall cleared OTC interest rate swap market. It regularly clears in excess of $1 trillion notional per day, and has cleared $40 trillion in client notional to date.

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