The recent financial crisis exposed weaknesses in the structure of the over-the-counter (OTC) derivatives markets that had contributed to the build-up of systemic risk. While markets in certain OTC derivatives asset classes continued to function well throughout the crisis, the crisis demonstrated the potential for contagion arising from the interconnectedness of OTC derivatives market participants and the limited transparency of counterparty relationships.
OTC derivatives benefit financial markets and the wider economy by improving the pricing of risk, adding to liquidity, and helping market participants manage their respective risks. However, it is important to address the weaknesses in these markets which exacerbated the financial crisis. To this end, building on the commitments set out in the Pittsburgh statement, the G20 Leaders committed at the subsequent Toronto Summit to accelerate the implementation of strong measures to improve transparency and regulatory oversight of OTC derivatives in an internationally consistent and non-discriminatory way.
This report includes 21 recommendations summarised below:
· Standardisation: The proportion of the market that is standardised should be substantially increased in order to further the G20’s goals of increased central clearing and trading on organised platforms, and hence mitigate systemic risk and improve market transparency. The report sets out recommendations for authorities to work with market participants to increase standardisation, including through introducing incentives and, where appropriate, regulation.
· Central clearing: To implement the G20 commitment effectively, it is necessary to specify the factors that should be taken into account when determining whether a derivative contract is standardised and therefore suitable for clearing. The recommendations do this, as well as address mandatory clearing requirements; robust risk management requirements for the remaining non-centrally cleared markets; and supervision, oversight and regulation of central counterparties (CCPs) themselves.
· Exchange or electronic platform trading: Further work is being set in train in the coming months to identify what actions may be needed to fully achieve the G20 commitment that all standardised products be traded on exchanges or electronic trading platforms, where appropriate.
· Reporting to trade repositories: Authorities must have a global view of the OTC derivatives markets, through full and timely access to the data needed to carry out their respective mandates. The recommendations help achieve this objective, including that trade repository data must be comprehensive, uniform and reliable and, if from more than one source, provided in a form that facilitates aggregation on a global scale.
This report aims to set ambitious targets for fully implementing the G20 commitments, while minimising the potential for regulatory arbitrage. It sets appropriate deadlines to meet the G20’s end-2012 commitments, and specifies bodies to take the recommendations forward.
Given the global nature of the OTC derivatives markets, continued international coordination in dealing with ongoing implementation of the G20 commitments is critical. Work should be taken forward by the relevant standard setters and authorities to achieve international consistency. Furthermore, given the continuous innovation in the OTC derivatives markets, this report identifies areas where monitoring will need to continue and exploration of additional measures is recommended.
The FSB OTC Derivatives Working Group will monitor implementation of these recommendations and provide an initial progress report to the FSB by 31 March 2011.
© Financial Stability Board
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