Buy-side unprepared for derivatives reforms as delays mount

Both buy- and sell-side market participants remain unprepared for impending regulation on OTC derivatives reform, according to a new report by research consultancy TABB Group.
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Both buy- and sell-side market participants remain unprepared for impending regulation on OTC derivatives reform, according to a new report by research consultancy TABB Group.

At the same time, US industry body the Securities Industry and Financial Markets Association (SIFMA) is preparing a letter to call for more time to allow banks to assess the impact of forthcoming rule changes in the US.

The TABB study, entitled ”Interest rate derivatives 2011: collateral damage in the duration market', suggests that only 40% of firms that trade interest rate derivatives have begun actively preparing for reform measures, while even fewer (27%) have analysed new OTC derivative cost structures. Regulatory uncertainty was cited as a key factor in the lack of preparation.

However the report's author, E. Paul Rowady Junior, a senior analyst at TABB, emphasised the need for anticipatory action by market participants. “Regulatory timelines are still up in the air but that doesn't mean the buy-side shouldn't begin preparing now for an era of more collateral costs and stringent reporting demands,” he said.

Derivatives reform has been a priority for regulators in recent months on both sides of the Atlantic. In the US, the Dodd-Frank Act was passed into law, which, as part of a wide-ranging reform programme, establishes a new regulatory framework for derivatives that aims to reduce risk primarily by greater use of central clearing and increased on-exchange trading. In May, the US Congress voted to give regulators more time to deliver some of the rules that will govern derivatives trading, when they extended the deadline for implementing Title VII of Dodd-Frank to 30 September 2012, with the exception of regulatory reporting rules and the definition of certain terms, including swap, security-based swap and security-based swap agreement.

Similar moves are under way in Europe, where the MiFID review and the new European market infrastructure regulation (EMIR) will reform OTC derivatives trading to achieve similar objectives to Dodd-Frank, in line with an end-2012 deadline set by the Group of 20 political leaders in the aftermath of the financial crisis.

The European Securities and Markets Authority is expected to issue a framework for technical standards relating to new OTC derivatives rules, which will determine which products will be deemed suitable for clearing, in May 2012.

However, the regulator cannot start market consultation until upcoming negotiations between the European Parliament and the Council of the European Union on the final text of EMIR are concluded.

In its draft letter to the US Securities and Exchange Commission (SEC), SIFMA cited a self-executing provision in Dodd-Frank that would subject security-based swaps to old securities laws, potentially introducing new additional compliance requirements that could pose a problem for banks unsure of the exact rules.

SIFMA is expected to seek further guidance from regulators on how banks should comply with the provisions of Dodd-Frank, as well as to request the SEC to hold off the introduction of most measures, including classifying security-based swaps as securities, for a further six months from their expected implementation date on 16 July.

Although US and European regulators have been at pains to ensure common outcomes to their parallel legislative efforts to reform derivatives trading, underlying tensions were revealed after US Treasury Secretary Timothy Geithner suggesting that the UK represented a “tragic” example of light-touch regulatory oversight in a speech that called on Asian jurisdictions to impose tougher restrictions on derivatives trading.

Anthony Belchambers, CEO of UK-based trade body the Futures and Options Association (FOA), said Geithner was “wrong” to cite the UK, adding that the ex-head of the New York Federal Reserve's comments did not appear to recognise that the SEC had taken a “no touch” approach in some areas itself.

“The FOA believes that supervisory failures were in evidence across many authorities and singling out individual jurisdictions is unhelpful in working towards a regulatory consensus,” Belchambers said.