The clock keeps ticking

Negotiators representing the European Commission, European Parliament and EU Council of Ministers recently reached agreement on the European Markets Infrastructure Regulation (EMIR), which sets out new European rules on clearing, bilateral risk mitigation and trade repository reporting. It is expected that the agreement will be endorsed by the European Parliament during the week of March 12-16; the Council of Ministers will also endorse it that month.

EMIR represents another milestone toward reaching the objective, set by the G20, of increasing transparency and reducing risk in the over-the-counter (OTC) derivatives markets. It aims to achieve risk reduction by requiring financial firms (as well as non-financial, subject to a threshold) to clear OTC derivatives “deemed” eligible (i.e., standardized) through CCPs, while it requires non-eligible OTC derivatives to be risk-managed under rules set out in the Regulation. It aims to achieve increased transparency by requiring the reporting of all derivatives (OTC or otherwise) to trade repositories (TRs).

The Regulation contains exemptions from the clearing requirements for non-financial companies, sovereigns, multi-lateral development banks, and other public sector entities that are fully guaranteed by their respective states. It also exempts pension funds for the next three to five years – pending creation, it is hoped, of suitable clearing solutions for such funds. Exempted from the clearing requirement are also intragroup transactions which meet certain requirements. Finally, EMIR also regulates CCPs and TRs, specifying the rules governing CCPs (e.g. in relation to risk management, capitalization, collateral and margin).

Many aspects of the legislation remain to be further defined and refined by ESMA and/or the various national regulatory authorities. Although the law is effective once it is published in the Official Journal, from a practical point of view, much of the detail will not be clear until ESMA (with the assistance of the other ESAs, or European Supervisory Authorities) thrashes out the details and the European Commission adopts relevant technical standards. The ESAs are expected to finish their work by end-September, with a further three months for the European Commission to approve them. At that point, the technical standards will come into force.

It’s clear that, given the uncertainty as to how exactly these standards will affect regulated firms, ESMA will need to deploy the scope it has been given in the main EMIR regulation to phase-in some aspects of the legislation (e.g. for clearing) for categories of counterparty. 
Following closely on EMIR’s announcement, ESMA has just come out with a 75-page discussion paper on draft technical standards. The topics to be clarified are organized around 83 questions and cover a wide variety of issues. Important questions, such as which OTC products are “deemed” eligible for clearing, remain open. Similarly, questions as to where such transactions will be cleared and as to the requirements of CCP authorization (and a lot of the detailed but important aspects of CCP governance, capitalization, and margining) also remain to be clarified. ESMA expects market participants to submit comments by March 19th.

ISDA has repeatedly stated its support for resilient and efficient markets. Regulatory infrastructure initiatives, such as clearing, contribute to these objectives. Moreover, ISDA supports a prudently managed transition to robust CCPs and, as such, it supports EMIR. It also supports the authority delegated to ESMA. Equally, though, we have expressed our concerns ‒ in a joint letter to EU Commissioner Barnier with other relevant trade associations ‒ that not enough time is being allowed for the proper consideration of these important issues.

Above all, we are concerned with the fact that large amounts of risk are in the process of being transferred to the CCPs without an adequate understanding of the sequencing involved, potential bifurcation of risk, and unwanted concentrations of risk in the newly formed (and untested) CCPs.

We are also concerned that parallel efforts in the US and European fronts may lead to an uneven playing field, giving rising to unwanted regulatory arbitrage, despite the stated objective by G20 to take action at the national and international level to raise standards together and “implement standards consistently in a way that ensures a level playing field and avoids fragmentation of markets, protectionism, and regulatory arbitrage.”

As we have highlighted in our letter to Commissioner Barnier, Danish Finance Minister Corydon and ECON Committee Chairman Bowles, it is essential that, as they approach critical rule-making mandates over the coming months and years, the ESAs are provided with the time and opportunity to succeed.

In the Key of OTC

The process of regulatory reform in the US and in Europe can sometimes seem discordant. Multiple regulators, ministries, politicians and policymakers produce a cacophony of proposals, counter-proposals, bills, statutes, directives, regulations and rules. Still, no matter the static, we have, at this point, the structure of Dodd-Frank in the US and the developing structure of EMIR and MiFID in Europe to provide some tonality, if not harmony, on approaches to regulation.

If the final movement is approaching in the US and Europe, where are we in the development of OTC derivatives regulation in other jurisdictions, particularly in the Asia-Pacific region? Without a single government or common market, is there any hope that regulation across the region will be in the same key, even if everyone plays a slightly different tune?

We won’t know the full answers for awhile, but in the meantime we will make every effort to broadcast information to the membership as regulations are composed across the region. To that end, we have just published our Asia-Pacific Regulatory Profiles, which serves as a handbook to regulatory developments affecting OTC derivatives in key jurisdictions throughout the region.

This new publication provides information on key regulators, on important recent and upcoming milestones and lists ISDA submissions on regulations in 10 markets. Some jurisdictions are part of the G20 and are striving to make good on the September 2009 commitments on clearing, execution and transparency. Others, though not bound by those goals, are nevertheless looking to emulate them. Yet another group may be driven more by domestic considerations and other public policy goals.

One issue that our Asia-Pacific report highlights is the approach in each of the countries to utilizing CCPs and trade repositories. Many jurisdictions are pursuing local solutions for their domestic markets and trades in their currencies. We have written about this previously in derivatiViews, where we highlighted the potential for proliferation of these key elements of market infrastructure and the possible detrimental effect of that proliferation on reducing systemic risk. We continue to raise this concern with regulators throughout the region.

Our staff in APAC remains active on these issues in both the established as well as developing markets. We will be making a stop later this month in Singapore where we will meet with members and regulators. Singapore has just announced that it is conducting a review on the regulatory oversight of OTC derivatives and is seeking public comment. After Singapore we will then travel to Hanoi, which we have visited once before, to hold a session on OTC derivatives with the Vietnamese central bank and other regulators. And in jurisdictions like Hong Kong, China, India, Korea and elsewhere, we have an established cycle of visits and working group meetings.

Wherever we travel in the region or, for that matter, around the world, our tune will be one of pursuing regulatory reform that is driven by the need to develop safer, more efficient markets. Anything else is just noise.