Canadian investment watchdogs may have the power for force certain OTC derivatives to be centrally cleared, under proposals set out by the country’s national regulatory body.
Canadian regulators are presently looking to refine their framework for the central clearing of OTC derivatives as major markets look to come into line with global commitments and a G20 mandate.
The new proposals have been set out by the Canadian Securities Administrators (CSA) in a new consultation paper, outlining the agency’s recommendations for clearing of OTC derivatives transactions through regulated central counterparties (CCPs).
The paper details recommendations on issues such as the process for choosing which OTC derivatives will be subject to mandatory central clearing, how CCPs should be regulated and governed, clearing member access, and risk management.
The CSA has proposed a combination of two approaches to defining what instruments should be cleared – mirroring European rules. The first is a bottom-up approach, through which OTC derivatives contracts that a CCP clears or proposes to clear are made subject to a mandatory CCP clearing requirement by a market regulator. The second is a top-down approach, where provincial Canadian market regulators have the power to identify instruments for which mandatory clearing is desirable, irrespective of whether a CCP clears or proposes to clear such contracts.
While the agency has long accepted central clearing of OTC derivatives was desirable, it has admitted in its consultation paper that not all instruments are liquid enough to be centrally cleared. The CSA said it understood that some derivatives were so illiquid imposing a central clearing obligation would result in either subjecting the CCP to unacceptable risk or requiring it to impose substantial margin requirements, which would cause the transaction to be prohibitively expensive to counterparties. In either case, inefficiencies in the market would result, and a mandate to centrally clear highly customised derivatives would effectively ban their use.
In Europe via the European market infrastructure regulation and in the US via Dodd-Frank, central clearing of OTC derivatives has been considered a key tool to reduce systemic risk in financial markets.
“The importance of bringing central clearing to OTC markets has been recognised by the G20 as one of the reform elements in the on-going effort to reduce systemic risk in the financial markets,” said Bill Rice, chairman of the CSA and chairman and CEO of the Alberta Securities Commission. “This paper is part of the CSA’s commitment to creating a Canadian solution to the question of central clearing,”
The CSA is the council of Canada’s provincial and territorial securities regulators, and it coordinates and harmonises regulation for Canadian capital markets. Market participants can submit comments to the consultation paper until September 21, 2012.