Regulatory Uncertainty Spooks Markets

Terry Flanagan

The prospect of an onslaught of new rules and regulations is creating uncertainty among industry participants, while regulators work to smooth over differences to address issues of extraterritorial scope.

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

In the United States, the Dodd-Frank Act requires the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (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—for example, Markets in Financial Instruments Directive (MiFID) and European Market Infrastructure Regulation (Emir)—get finalized.

“While uncertainty is very high, it is highest for the regulations which have not been translated into final rules yet,” Max Dufour, principal at software provider SunGard Global Services, told Markets Media.

“Uncertainty is high when proposed rules are complex, demanding and applied by multiple agencies without the test of time to validate the process,” said Dufour. “As of March, 225 Dodd-Frank rulemaking requirement deadlines have passed out of 400, and 286 rulemaking requirements have deadlines.”

The CFTC has entered the crucial “definitional phase” of rule making under Dodd-Frank, upon which hinges all the other rules for regulating the OTC swaps market.

It is working on a final rule that will define “swap dealer”, “security-based swap dealer”, “major swap participant”, “major security-based swap participant” and “eligible contract participant”.

“The process with which regulators have gone about creating rules is strange,” Hester Peirce, senior research fellow at George Mason University, told Markets Media. “Entity and product definitions should have been tackled first. It’s impossible to comply with rules unless you know the scope of what they cover.”

In Europe, derivatives lawmaking is currently divided between Emir, which deals with central clearing and trade repositories, and Markets in Financial Instruments Regulation (MiFIR), which deals with trade execution.

A text of Emir has been agreed by the Council of Ministers of the European Union and the European parliament.

Emir now gets handed off to the European Securities and Markets Authority (Esma), which is tasked with creating implementation rules, known as Level 2 in the regulatory process.

Esma will need to have Level 2 rules in place by end of September so that they can be approved by the European Commission (EC) by the end of December.

In Europe, the development of financial service industry regulations is prescribed by the Lamfalussy Process, which is composed of four levels, each focusing on a specific stage of the implementation of legislation.

“Based on the Level 1 text of Emir, which hasn’t yet been made public, Esma is drafting a Level 2, after which the EC will publish a final Level 2 text,” said Florence Fontan, head of public affairs, strategy and corporate development at BNP Paribas Securities Services. “Because Emir is a regulation, it doesn’t require transcription by member states.”

The SEC and CFTC are working on a project of the International Organization of Securities Commissions (Iosco) to co-ordinate 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.

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