A consultation that will decide which derivatives are to be centrally cleared and which will remain OTC is due to start “shortly”, according to Alexander Justham, director of markets at the UK’s Financial Services Authority, but timelines to implement regulators' recommendations depend of impending negotiations between the European Parliament and the Council of the European Union.
The European Securities and Markets Authority (ESMA) is expected to conclude its consultation exercise in May 2012 by issuing a proposed framework for technical standards relating to new OTC derivatives rules, which will determine which products will be deemed suitable for clearing.
Justham's comments were part of his keynote address at the International Derivatives Expo held in London today. While noting that progress has been made by both regulators and market participants, he emphasised that much remains to be done.
“We are about halfway through the process now and substantial progress has been made,” said Justham, chair of the secondary markets standing committee at ESMA. “However, there is still much to do. We must ensure that all of the actions we take to reform the OTC market are not formulaic, but are in tune with the objective of reducing systemic risk.”
The financial crisis of 2008 led to the demise of many of the world's largest financial institutions, such as Lehman Brothers, Bear Stearns and AIG, which in turn exposed many OTC derivative market participants to counterparty risk. In 2009, the Group of 20 (G-20) political leaders agreed to shore up the market by enforcing central clearing and exchange trading of swaps where appropriate, calling for the creation of data repositories to promote better transparency and requiring non-cleared OTC derivatives to be subject to higher capital charges.
Europe is addressing the G-20's clearing and data repository commitments via the European market infrastructure regulation (EMIR), while the US has included its OTC derivatives reform package in the Dodd-Frank Act.
A spokesperson for ESMA confirmed that its consultation process will start once the final text for EMIR has been finalised by the European Parliament (EP) and Council of the European Union. The Council is currently debating EMIR, with political pressure mounting to finalise a text before the end of this month. The roles of ESMA and national regulators, within the new supervisory regime are among the sticking points between the two bodies.
One reason for concern over a protracted delay in finalising EMIR is that it will give ESMA, which can't stand its consultation until the politicians have reached agreement, less time to conduct its consultation. Any slippage in the schedule will give market participants less time to adopt them before the end of 2012, the G-20 deadline for completion of OTC derivatives reform.
“The FSA are doing the right thing, in terms of seeing the need for the consultation to start sooner rather than later,” said Anthony Kirby, director of risk and regulation at Ernst and Young. “However, there are so many types of firms that will need to be consulted, outside of the financial industry, and this could delay the process and leave little time for firms to adopt the new rules before the G-20 deadline of the end of Q4 2012.” A survey issued by the International Swaps and Derivatives Association in 2009 indicated that 92% of interest rate swap and 88% of FX swap usage was by utility companies. “Applying a proportionality test to all corporates, utility companies and municipalities to determine systemic relevance (by information or clearing thresholds) might be a considerable challenge given we have fewer than 18 months by way of countdown,” added Kirby.
In creating new rules for clearing OTC derivatives, Justham stressed the importance of consistency, not just between the US and Europe, but also in Asia, where OTC reforms, such as in Singapore and Hong Kong, are being pursued individually.
“Inconsistency, particularly if exacerbated by capital requirements that don't deliver an incentive to clear, could create enormous arbitrage problems and issues within the market place,” he said. “There tends to be a focus across the US and Europe, but there has to be global consistency, and Asia has to be an important part of this as well.”
Justham added that International Organisation of Securities Commissions (IOSCO), which represents global regulators, is due to release a report in early 2012 to advise which products should be made eligible for clearing.