The main issue for firms and regulators is that the details we’re focusing on at the moment, in this final delivery stage, also happen to be some of the most important facing the derivatives industry:
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the cross-border application of derivatives rules
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implementing new requirements for the collateralisation of bilateral derivatives
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preparing for the current batch of European Market Infrastructure Regulation (EMIR) requirements
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resolving issues around benchmarks.
These are all touchstone issues in the world of derivatives. Not matters of great public debate – not the stuff of front-page headlines – but our handling of them will go a long way towards determining how history judges our response to the economic crisis…
Quite rightly, the big global economies are unwilling to stand back and allow the derivatives market to stockpile risk in one corner of the world, only to see it transmitted back to their own consumers. But in all the discussions I’ve heard, what I don’t think is clear yet, or well enough understood, is how the application of domestic rules in regulated international markets makes this stress scenario any less likely.
The important point here is that international derivatives reform is designed to do its job – in other words to reduce risk and increase transparency – with or without the application of domestic cross-border rules. So the issue then becomes: does it make hard-nosed, practical sense for any one national regulator to attempt to regulate all derivatives activity with any link to its jurisdiction?
The clear risk is that a patchwork quilt of national and regional rules runs the risk of becoming unworkable. A mess. Creating space for overlaps and under-laps in regulation, with all the question marks that brings with it: opportunities for regulatory arbitrage; less protection for end users and lower margins for firms that operate by the book.
There’s also the linked danger that if every national regulator follows suit, you soon create a tit-for-tat environment where any one transaction, or participant, could easily be subject to three, four or five different regulatory regimes.
Clearly it is an imperative to make sure these fears aren’t realised. Not just in terms of commercial pressures on industry. But also on the more important prize of financial stability. No-one wants a repeat of 2008.
Our colleagues in the US Commodity Futures Trading Commission (CFTC), along with the European Commission, have made significant strides over the last year to resolve these issues, making real progress in the Path Forward agreement. We should all welcome this momentum but it’s also important to remember the document is, as its title suggests, a roadmap rather than a complete solution. There remain significant points of detail to work through.
The most urgent of these relates to trading venues – particularly trading venues in the EU and US – used by firms in both territories as major conduits for transatlantic derivatives trading. It’s not uncommon for half of transactions on London-based trading venues to have a US firm on one or both sides. So you need to find an approach to cross-border regulation that allows this liquidity to be maintained. The FCA, along with the EU, is pushing hard for this approach to be based on mutual recognition. The catch here is in the timing. We need to make rapid progress given the October deadlines we’re working towards under the SEF regime.
The second, related, area to mention is around the broader recognition of equivalence between different international regimes. ISDA has already pitched a pretty convincing argument in favour of domestic regulators accepting compliance with foreign rules for cross-border trades – always assuming those rules yield an equivalent outcome. On the face of it, I think this makes good sense. Otherwise you have to be able to demonstrate the value of insisting trades conform to your own laws, when they’re already doing so through someone else’s.
If you can’t do that, it’s hard to see how limits on the scope of provision for this kind of substitute compliance would work – except where it’s merited by a lack of equivalent foreign rules. So, yes, we should applaud the additional commitments in the Path Forward paper for broader substitute compliance. But I strongly suspect international regulators are going to come under pressure to make more progress in finding global solutions to these global challenges – not least in achieving some kind of international consistency on the regulation of market infrastructures...
The eye of the world may have moved on to other places, other reforms, other concerns since the G20 Pittsburgh conference in 2009. But for the rest of us involved in derivatives reform, this is the most critical moment of getting the detail right. The regulatory equivalent of taking care of the pennies so the pounds can take care of themselves.
Full speech
See also: Speech CFTC/Gensler
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