Surf’s Up!

Summer is here and the beaches are open in the US, Europe and elsewhere. How appropriate then that the second wave of mandatory clearing has now hit US shores.

This is an important development, and marks a big step forward in reducing counterparty credit risk through clearing, which is one of the two major strategic G20 initiatives to reduce systemic risk.  (The other – increased regulatory transparency – is being accomplished through trade reporting and the establishment of trade repositories.) At this point, the vast majority of interest rate and credit default swaps in the US must be cleared.

The first wave of mandatory clearing in March covered the (relatively) low hanging fruit, entities like dealers and active traders that were already clearing or well-prepared to do so.

The June wave of mandatory clearing covers a wider swath of the asset manager and fund communities. The focus has been on putting in place legal documents and operational arrangements that will enable these entities to clear the interest rate and credit default swaps for which clearing is now mandated. Dealers, clients and regulators will be closely observing this experience as many of these entities will be clearing trades for the first time.

ISDA has worked with its members to address the challenges of this new wave of mandatory clearing. The phased implementation adopted by the CFTC was an outgrowth of discussions between ISDA and the CFTC dating back to 2011. The documentation that firms are using is based on the FIA-ISDA Clearing Addendum published a year ago. And we announced on Monday that four dealer firms have announced their support for the Clearing Connectivity Standard (CCS) we are developing with Sapient to facilitate reporting of cleared swaps. We believe CCS provides a sound basis for reporting and communication, initially here in the US and, in due course, around the world.

And the clearing tide is rising in other parts of the world. ISDA is working with its members and regulators in other jurisdictions to anticipate those developments. This week we announced, together with the Futures and Options Association, the publication of a clearing addendum for use in the European context in clearing arrangements that use a principal-to-principal arrangement, instead of the agency model (FCM) required in the US. While driven by the upcoming clearing requirements under EMIR, the ISDA-FOA addendum can be used in any jurisdiction where the principal arrangement is used.

The final wave of mandatory clearing in the US arrives in September. The experience of the first two waves and the efforts of ISDA and its members to date will, we believe, position the swaps industry well as that next wave comes ashore.

And let’s not lose sight of the broader landscape of regulatory reform and the progress that has been made.

The September 2009 G20 commitments in Pittsburgh provide the contours of reform, with clearing and trade reporting foremost among them. Sure, there are issues firmly on the horizon yet to be fully resolved (SEF implementation, MiFIR, extraterritoriality, initial margin, to name a few). But the progress made on clearing and trade reporting is significant, something we’ll be reporting on soon in our semiannual market analysis.

So that’s the lay of the land – and the sea – of derivatives regulatory reform.

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