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International OTC derivatives reforms. Chris Bates, Partner, Clifford Chance, London. September 2012. Forces shaping regulation of OTC derivatives. Regulation is being shaped by several powerful forces The financial crisis The euro crisis The G20 agenda Global rebalancing
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International OTC derivatives reforms Chris Bates, Partner, Clifford Chance, London • September 2012
Forces shaping regulation of OTC derivatives • Regulation is being shaped by several powerful forces • The financial crisis • The euro crisis • The G20 agenda • Global rebalancing • Competition policy • Politics • Differing views from global regulatory bodies The effects are beginning to profoundly alter the shape of the OTC derivatives market There is a lot of legislation and still a long way to go......
The international agenda • *G20 agenda item International OTC derivatives reforms
Marketreforms – G20 commitments • “All standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest. OTC derivative contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements.” • G20 Pittsburgh, September 2009 4
Simple instructions, complex outcomes • Obligation for counterparties to clear eligible OTC derivatives with registered central counterparties (CCPs) • Obligation to execute eligible transactions through a trading system, not bilaterally • Obligation to report all transactions to a registered trade repository • Obligation to collect/post initial or variation margin on uncleared transactions • Regulation of confirmation process, portfolio reconciliation, trade compression and client documentation • Pre- and post-trade transparency for OTC transactions • Position limits/position management powers for commodity derivatives • Licensing or registration requirements for dealers and systemically important end-users • Business conduct rules for market participants, extension of market abuse rules • Regulation of CCPs and trade repositories International OTC derivatives reforms
Points of difference • Different pace of reform around the world • US, EU, Asia • Clearing, reporting, margining vs. trading, transparency • Scope issues • Instruments: e.g. FX, physical commodities and securities • Entities: e.g. treatment of end-users, intra-affiliate trades, pension funds, central banks • Margining of uncleared trades • Initial margin and collateral thresholds • Extraterritoriality and overlapping, conflicting rules • Different approaches to territorial nexus e.g. location of counterparties, arranger, transaction underlying • Extra-territorial application of licensing rules • Regulation of CCPs and trade repositories
Basel III • Basel III supplemented by national initiatives to raise bank capital • EU and US stress tests • Additional capital buffers e.g. UK, Sweden, Austria, Switzerland • More, better quality capital and enhanced deductions from capital • Focus on equity and additional buffers, including G-SIB buffers • Plus unweighted leverage ratio • Increased risk weights for assets affect OTC derivatives • CVA: credit valuation adjustment • Additional capital charge for exposures to large financial institutions • Capital charges for client business cleared with a CCP • Trading book review • Liquidity risk regulated through liquidity coverage ratio and net stable funding ratio International OTC derivatives reforms
Bank structural initiatives • *G20 agenda item International OTC derivatives reforms
Recovery and resolution • International convergence of resolution regimes • Financial Stability Board publishes key attributes • Requirement for recovery and resolution planning • Possible resulting structural changes to banks to facilitate resolution • Recognition that ordinary insolvency regimes inadequate for systemically important institutions • US FDIC/orderly liquidation regime, UK Banking Act, German regime, EU proposed directive • Debate over the role of “bail-in” as a resolution tool • Write down of junior and senior liabilities or conversion into equity • Impact on derivatives International OTC derivatives reforms
Market outcomes • Restriction on banks’ derivatives capacity • Client and bank response may result in regional booking silos • Reduction in product range • Increased barriers to entry for smaller market participants • Increasing importance of CCPs • Focus on financial stability issues and market structure • Possible new market entrants: “shadow banks” • Winners and losers International OTC derivatives reforms