Former New York City Mayor Ed Koch was famous for asking New Yorkers “How am I doin’?” The response gave him a quick job rating from his constituents. Sometimes it was a cheer, sometimes a boo.

With the publication this week of a series of final rules from the CFTC, it might be timely to ask “How are we doin’?” This set of rules covers a range of issues, including confirmations, valuation, portfolio reconciliation, dispute resolution and compression. In short, it’s a laundry list of what ISDA and our members have been focusing on in recent years to deliver safe, efficient markets.

And we’re happy to report that, on balance, the final rules would seem to us to elicit more cheers than boos.

For example, one important issue involves an extension of the time period for compliance with a set of external business conduct rules. This extension was important for purely practical reasons as much remains to be done by market participants to amend their contracts to address these rules. The process of doing so began with the recent launch of the Dodd-Frank Protocol and ISDA Amend, a joint ISDA-Markit initiative that automates part of the required compliance. We already have over three dozen adhering parties and we expect that number to grow substantially over the next month or so. But even with the efficiencies provided by those processes, mid-October was looking like a stretch to get everyone—buy side, corporates, pension funds and others—on board. So the extension was much needed.

In other portions of the release, ISDA’s comment letters are cited as the basis for changes in the final rules. Our positions, of course, were not adopted across the board and some concerns remain, but many critical parts of the rules reflect a reasoned approach to achieving regulatory goals. For example, the CFTC decided not to apply the rules retrospectively, something we advocated. On disputes, the difference in valuations must exceed 10% before dispute mechanisms are triggered and reports of disputes to the regulators are required if the dispute exceeds $20,000,000. The time periods for resolving disputes have been extended although they are still shorter than we advocated or have been working toward in our ongoing collateral committee efforts.

Also, the release acknowledges the successful efforts undertaken with the OTC Derivatives Supervisors Group, led by the New York Fed, to address issues such as confirmation backlogs and portfolio reconciliation. In executing its legislative mandate, the CFTC must put its own stamp on these issues while building on the real progress made through ISDA’s and the industry’s efforts with the ODSG.

The CFTC also acknowledges in several instances the central role played by ISDA documentation, the global standard for documenting derivatives. That’s an important consideration, particularly as we proceed with many amendments to the documentation driven by the Dodd Frank Act. The CFTC does not explicitly endorse ISDA documentation because it points out parties can—and do—negotiate variations to those terms. We are, after all, dealing with privately negotiated bilateral contracts.

Finally, the rules indicate that the CFTC will not view failure to comply with documentation and confirmation requirements as a violation of the rules or the Dodd Frank Act so long as procedures are in place to comply and there is a good faith effort to follow those procedures. This is a practical approach, and it is encouraging that the CFTC is motivated to encourage compliance and appears not to be constructing traps for the unwary.

We and our members will continue to study these final rules to identify implementation challenges and concerns. We look forward to a constructive dialogue on these issues in order to foster safe and efficient markets.

And in the meantime, feel free to let us know how we’re doin’.

We launched derivatiViews just about a year ago, and one need only look at the topics we have covered to get a sense of the issues we and the OTC derivatives industry have been facing. Let’s take the opportunity to reflect on some of those issues and also consider what lies ahead.

Of course, regulation and its implications have been a steady focus of derivatiViews. We have tried to be constructive in our commentary, recognizing the challenges that regulators face as they create a new regulatory regime. For instance, we acknowledged the notion under CFTC rules of the “legally separated, operationally comingled” approach to cleared margin segregation as a serious effort to balance a range of different views. Similarly, although we are still studying the details of the product definition rules, we recently noted the hurdles that the CFTC and the SEC had to clear to get to a final rule. The issues facing other regulators, particularly those in Asia, have been a periodic theme of our posts.

One development we wouldn’t have anticipated a year ago was that we would be in litigation against a regulator, specifically the CFTC. As we explained in December, this was not a step we took lightly, but we, together with our co-plaintiff, the Securities Industry and Capital Markets Association, believed that the way position limits had been considered in the rulemaking process, particularly the lack of consideration of the costs and benefits, cried out for scrutiny by the courts. As of this writing we are still awaiting word from the judge on the case. Regardless of the outcome on the case, we will remain engaged in the US, Europe and around the world in achieving a regulatory structure that works for everyone affected by derivatives. Which is pretty much everyone.

The continuing financial crisis in Europe provided ample opportunity for us to comment. We used this platform to further understanding about the role of CDS, the need to understand the legal terms and the importance of collateral in helping to reduce risk in these trades. When, in the end, the EMEA Determinations Committee decided that the forced restructuring of Greek debt constituted a credit event, we reflected on the many lessons learned and highlighted steps that we would take in light of that experience.

Halfway through this year it is also an opportunity to reflect on progress on our resolutions for the new year. We have remained actively engaged in capitals around the world on the issues affecting our industry. We are also in contact with global bodies, such as the Basel Committee, the Financial Stability Board and IOSCO, which play an increasingly important role in regulatory for this global business. We commented on the recent progress report by the FSB on progress toward the G20 commitments, which acknowledged the progress that has been made, particularly on clearing, and the significant work that remains to be done. It also acknowledged that market liquidity should be a consideration as countries consider mandates for execution, which had been the subject of a derivatiViews post from late last year.

We also remain focused on the steps necessary to increase safety and efficiency of our markets, including the many aspects of clearing, from documentation to margin to capital. In just the past few months we have remarked on the demands on collateral given the reliance on it in cleared and uncleared trades, the connectivity between the cleared and the bilateral world and the challenges of achieving meaningful consistency in data and reporting. Each of these issues has serious implications for the safety and efficiency of our markets.

We will continue to pursue our stated goals for the remainder of this year and beyond. And we will be prepared to address new developments that will no doubt drive our agenda. Whatever develops, please continue to check back here at derivatiViews for our take.

In many parts of the world, schools have come to the end of their terms, which makes it a nervous time for students: they are waiting for the report card to arrive. We at ISDA empathize, as we too have been waiting for a report card. It came this past Friday, in the form of the Financial Stability Board’s Third Progress Report on Implementation of OTC Market Reforms. The report measures progress toward the G20 commitments to reform OTC derivatives markets, agreed upon at the 2009 meeting in Pittsburgh.

So how did the OTC derivatives markets do?

Pretty well. As the report states:

Since the FSB’s previous progress report in October 2011, encouraging progress has been made in setting international standards, the advancement of national legislation and regulation by a number of jurisdictions and practical implementation of reforms to market infrastructures and activities.

One part of the report – the FSB’s discussion of exchange and electronic platform trading and market transparency – was especially encouraging. It elaborates on a recommendation to consider costs and benefits from their October 2010 report by explicitly adding that, “Authorities need to take action to explore the benefits and costs of public price and volume transparency…. including the potential impacts on wider market efficiency, such as on concentration, competition and liquidity.” We can’t say that the FSB has read our cost-benefit analysis of the Dodd-Frank requirement for SEF execution, but that sounds very familiar to the cost concerns that we raised in that study.

The biggest takeaway is that much remains to be completed by the end-2012 deadline to achieve the G20 commitments. The FSB leaves no doubt that they will be closely watching and driving for progress in the months ahead.  As it states:

For the next progress report, the FSB intends to put additional focus on the readiness of infrastructures to provide central clearing, platform trading and reporting of OTC derivatives, the practical ability of industry to meet the requirements and the remaining steps for industry to take.

The report acknowledges that the largest markets in OTC derivatives – the EU, Japan and the US – are the most advanced in their progress. It also recognizes that other jurisdictions are understandably waiting for those three regions to finalize their approaches before committing to a particular path of reform. It urges all jurisdictions “to aggressively push ahead to achieve full implementation of market changes by end-2012 to meet the G20 commitments in as many reform areas as possible.”

That’s the assignment for the public sector. But the FSB also has some assignments for the private sector, ones that we at ISDA are actively engaged in. Market participants are urged to address standardization, clearing, trading on organized platforms and reporting to trade repositories. Check, check, check and check – those are on ISDA’s agenda as well.

In short, the report card was delivered, but there will be no extended summer break for the OTC derivatives industry or all of us here at ISDA.

Is the OTC derivatives market larger or smaller than 5 years ago? How much progress has the industry made in central clearing? By how much does netting reduce credit exposures?

If these and questions like them are of interest, have a look at the latest edition of ISDA’s Market Analysis. The paper integrates market data from a variety of sources – the BIS, clearinghouses and ISDA itself, to name a few – to show the impact of clearing, netting, compression and collateral on notional amounts and risk exposures in the over-the-counter (OTC) derivatives markets.

Take the first question above: the size of the OTC derivatives markets. If you look at notional amounts published by the BIS, you can see the size of the market increased by about 11% over the past five years. On an adjusted basis, however, the market declined by 9%.

What accounts for the difference? Two things. First, our analysis eliminates double-counting of cleared swaps. Clearing increases volumes (as one swap between counterparties is transformed into two swaps between each counterparty and the clearinghouse), even as it is designed to reduce risk. It’s worth noting that the cleared volume of interest rate swaps totaled 53.5% of IRS outstanding at year-end. That’s the highest percentage yet and it’s a 151% increase over year-end 2007. Second, our analysis also excludes FX transactions (as they are in many ways unlike other OTC derivatives).

So on an adjusted basis, the market has declined. Why? One of the key factors is compression. Over the past decade or so, compression has reduced notionals outstanding by a little over $200 trillion, including some $120 trillion in interest rate derivatives and $80 trillion in credit default swaps. Compression is clearly one of the biggest factors driving changes in the volume of derivatives outstanding.

So far we’ve talked about notionals, which measure activity but not risk. Gross market value (GMV) reflects that risk by measuring the cost of replacing contracts. As the BIS reported, GMV increased for the period ending December 31, 2011 from mid-year 2011. Netting (a subject close to ISDA’s heart given our role in ensuring it helps firms reduce risk) lowers credit exposure to 14.3% of GMV and 0.6% of notionals. Collateralizaton reduces credit exposures to an even lower level.

We think these statistics tell an interesting story, even if it is not the tale that is often told. But that’s why we started the Market Analysis in the first place. We hope it leads to a more informed view of the key trends shaping the global OTC derivatives market.

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For further insight, listen to yesterday’s derivatiViews post, a short interview with ISDA CEO Bob Pickel about the Market Analysis.

Listen to a short discussion with ISDA CEO Robert Pickel on the new report, “OTC Derivatives Market Analysis Year-end 2011″ (click here to get the report).

Are European banks more active in the OTC derivatives markets than US banks?  A look at their balance sheets might lead you to think so. For example, reporting under IFRS, Deutsche Bank’s total assets amounted to $2.1 trillion, of which 40% (or $863 billion) were derivatives. Bank of America, by contrast, has $2.2 trillion in assets, of which derivatives constitute just 4%.

How can this be?

The difference, of course, lies in the accounting treatment of derivatives. US GAAP accounting standard setters have consistently agreed that derivatives be reported on a “net” basis instead of on a “gross” basis on the face of the balance sheet. Historically, the Europe-based International Accounting Standards Board (IASB) has permitted significantly less balance sheet offsetting than the US-based Financial Accounting Standards Board (FASB). (Note: the table below shows the actual derivatives outstanding of some US and European banks as of year-end 2009.)

ISDA believes that net presentation, in accordance with US GAAP, provides the most faithful representation of an entity’s financial position, solvency, and exposure to credit and liquidity risk. Individual derivative transactions that are subject to enforceable master netting agreements should be eligible for netting in the balance sheet on the basis that such financial statement presentation is most faithfully representative of an entity’s resources and claims and provides the most useful information for investment decisions.

The fact is, netting is recognized for legal, regulatory and regulatory capital purposes. The treatment of netting under US GAAP ensures the accounting practices regarding netting are appropriately aligned with this state of affairs. The IFRS approach, in our view, creates distortions and misperceptions in the treatment of derivatives.

This matters, particularly in today’s environment, where OTC derivatives are castigated for reasons both fair and foul. The gross presentation, for example, fuels critics who believe that too much financial activity serves no useful purpose or that it diverts resources from more productive activities.

To help clear the air, ISDA recently published a paper, Netting and Offsetting: Reporting Derivatives Under US GAAP and Under IFRS. It really helps to explain an issue that’s important but all too often misunderstood.

Much has been written about the OTC derivatives clearing obligation, which is due by end-2012. However, what is perhaps less transparent is that the clearing mandate is about much more than clearing.

One of its primary features, for example, is reporting. The CFTC has issued a number of rules in this regard (Parts 43 and 45) which prescribe detailed reporting requirements. CFTC rules call for the electronic reporting of all swap data to Swap Data Repositories (SDRs) following execution of trades. Potential reporting entities are SEFs (Swap Execution Facilities), DCMs (Designated Contract Markets), DCOs (Derivatives Clearing Organizations), SDs (Swap Dealers), MSPs (Major Swap Participants) and swap counterparties who are neither swap dealers nor major swap participants (non-SD/MSP counterparties) including counterparties exempt from the clearing requirement.

SDRs must maintain all swap data reported to them in a format acceptable to the regulators. The CFTC has even specified the format in which such data will be reported. In order to enhance its ability to conduct effective market surveillance (and thus mitigate systemic risk and prevent market manipulation), the CFTC has specified data conventions such as Unique Swap Identifiers (USI), Legal Entity Identifiers (LEI) and Unique Product Identifiers (UPI). These unique identifiers are crucial for linking data together and enabling data aggregation across counterparties, asset classes and trades.

The industry welcomes all these regulatory initiatives. We have stated repeatedly that we fully support complete regulatory transparency. At the same time, we have expressed our reservations with respect to the interaction between public transparency and liquidity.

Regarding the data initiatives specifically: We welcome the CFTC’s efforts to provide more structure to the reported data through the introduction of USIs, LEIs and UPIs. As the Bank of England’s Andrew Haldane put it in his March 2012 speech, “Today’s financial chains mimic product supply chains of the 1980s and the information chains of the 1990s. For global supply chains and the internet, their fortunes were transformed by a common language… They are astonishing success stories…. A common financial language has the potential to transform risk management at both the individual-firm and system-wide level.”

Equally, we see a number of useful applications that could come out of the creation of this unique identifiers infrastructure. Apart from enhancing the ability of regulators to monitor activity and risk in the system, these developments are likely to revolutionalize the financial services industry and will, most likely, lead to the creation of another cottage industry specializing in applications from these data.

There are, though, some troubling aspects of the reporting requirement that could lead to potential issues for all involved, including the CFTC itself, let alone the industry which is working diligently to meet the July 16 date on which reporting becomes effective in the US.

• First, the CFTC, in order to prevent data fragmentation, requires that all data for a swap must be reported to a single SDR. Yet, the CFTC allows for the creation of several SDRs per asset class, creating the potential for faulty double reporting, overlapping of data, and most importantly, the potential need for an SDR for SDRs per asset class;

• Second, there are similar reporting initiatives in other jurisdictions, creating again the possibility for the requirement that the same transaction has to be reported to two different trade repositories in two different jurisdictions. This has to be avoided at all costs;

• Third, the data structure proposed by CFTC is a US regulatory initiative. It is hoped that it will be accepted by other jurisdictions around the world. Establishment of parallel data structures by other regulatory authorities would be an expensive calamity and would create a significant hurdle to achieving greater transparency.

We will be watching with interest developments in this regard as they promise to be exciting and potentially transforming for the industry.