17 December 2009

UK authorities object forcing standardised OTC contracts to organised trading platforms

The UK Treasury and the FSA laid out the UK perspective on reforms of the OTC derivatives markets. Supporting greater standardisation, authorities see no benefit in forcing trade flow through organised platforms given the current proposals achieve the intended outcome.

A greater standardisation of products should not be the only criterion to consider when determining whether a product should be cleared, the UK authorities state and strongly support uniform set of high standards for the clearing houses for eligible derivatives, supervised by home state regulators.

 

Trades which are not centrally cleared should be subject to robust bilateral collateralisation processes and/or the appropriate risk-proportionate capital charge.

 

The UK calls for the registration of all OTC derivative transactions in a trade repository

 

Given the requested outcome, the FSA and UK Treasury sees no need forcing trade flow through organised trading platforms. “We urge legislators on both sides of the Atlantic to approach this regulatory tool with caution as regulatory objectives can be achieved by other means”, they say.

 

Authorities also warn against pre-judging the work that is currently underway within the international regulatory community and in partnership with the industry. “It is essential that … careful consideration is given to this work when defining legislation; and that there is not an unnecessary duplication of efforts”, they state.

 

In summary, the Treasury and the FSA propose that the following measures need to be implemented and/or developed to address systemic shortcomings in OTC derivative markets:

 

 

Ø  Greater standardisation of OTC derivatives contracts. Greater standardisation would enhance the efficiency of operational processes; facilitate the increased use of central counterparty (CCP) clearing and trading on organised trading platforms, and support greater comparability of trade information. We will work with international regulators and the industry to take steps to identify and agree which products can be further standardised, both in terms of underlying contract terms and operational processes, and ensure that this is implemented on a timely basis.

 

Ø  More robust counterparty risk management. All OTC derivative trades, whether or not centrally cleared, should be subject to robust arrangements to mitigate counterparty risk. For all financial firms this should be through the use of CCP clearing for clearing eligible products. For trades which are not centrally cleared these should be subject to robust bilateral collateralisation arrangements and appropriate risk capital requirements. This approach may differ for non-financial firms given the different nature of the risks they pose to the financial system. It is important that all participants bear the cost of managing the risk they pose.

 

Ø  Consistent and high global standards for Central Counterparties (CCPs).

Ø  Increased use of CCPs will heighten their systemic importance so it is crucial that they are regulated to high standards, consistently applied in the major jurisdictions.

 

Ø  We are working in CPSS-IOSCO and the Basel committees to revise existing standards. In Europe, the UK has been leading calls for a Clearing Directive and will press to ensure this is an effective tool in mitigating any risk that CCPs will pose to the financial system.

 

Ø  International agreement as to which products are ‘clearing eligible’. This will require assessment by both regulators and CCPs in deciding which products are eligible for clearing. In addition to the degree of standardisation, consideration must also be given to the regular availability of prices; the depth of market liquidity; and whether the product contains any inherent risk attributes that cannot be mitigated by the CCP. Once clearing eligible products are identified, regulators should set challenging targets for CCP usage with active monitoring of progress against these rather than mandate the use of CCP clearing.

 

Ø  Capital charges to reflect appropriately the risks posed to the financial system.

Ø  These should be higher for non-centrally cleared trades and we are working through the Basel Committee to deliver a proportionate approach. Capital charges for exposures to CCPs should also be risk-based.

 

Ø  Registration of all relevant OTC derivative trades in a trade repository.

Ø  This will facilitate regulators having appropriate access to the information they need to fulfil their regulatory responsibilities. We are working through the OTC Derivative Regulators Forum (ORF) to deliver this across a number of asset classes.

 

Ø  Greater transparency of OTC trades to the market. Access to better information around prices and volumes can help price formation and market efficiency.

Ø  However, this should be calibrated to minimise scope for an adverse impact on liquidity, and consideration should be given to using existing reporting channels to minimise costs.

 

Ø  On-exchange trading. Once these steps have been taken we do not see at this stage the need for mandating the trading of standardised derivatives on organised trading platforms. Regulatory objectives of reducing counterparty risk and improving transparency can be achieved by other means and we will review progress of initiatives in this area. Moreover, mandating the use of organised platforms would imply a regulatory imposition of trading structure, which we do not believe is necessary.

 

Full report

 

© FSA - Financial Services Authority