The FSB's Report Card on Derivatives Reform

By George Bollenbacher, G.M. Bollenbacher & Co., Ltd.

Originally published on Tabb Forum 

Earlier, I covered a report to the OTC Derivatives Regulatory Group (ODRG) meeting on resolving the international requirements for derivatives reform that the G20 passed in 2009. As it happens, the Financial Stability Board (FSB) published a report card on this same subject on April 15.

It shouldn’t surprise us that the cross-border aspect of derivatives reform is so much in the news today, since that is where the next big efforts will have to be made. Global market participants that are still heavily focused on Dodd-Frank are in danger of missing the bus, which is getting ready to leave the station.

The report card doesn’t start off on a positive note. It reads:

“While progress has been made in moving these markets towards centralised infrastructure, less than half of the FSB member jurisdictions currently have legislative and regulatory frameworks in place to implement the G20 commitments and there remains significant scope for increases in trade reporting, central clearing, and exchange and electronic platform trading in global OTC derivatives markets.”

Like a reproachful teacher, the FSB takes the jurisdictions to task for their slow progress:

“The FSB reiterates that, even though standards are still being finalized in a few areas, sufficient international guidance is overall available to jurisdictions to decide and implement policy frameworks for ensuring the G20 commitments are fully met in their jurisdictions, and that any necessary reforms to regulatory frameworks should be made without delay. This includes ensuring that there are no legal barriers to reporting all OTC derivatives contracts to trade repositories (TRs) and to the central clearing and organised platform trading of standardised OTC derivatives contracts... The FSB urges jurisdictions to clarify their respective approaches to cross-border activity, and to resolve any conflicts and inconsistencies as quickly as possible to provide certainty to stakeholders.”

Then the report gets into the details of the three major efforts: reporting, clearing, and centralized trading. Inreporting, the FSB points out one of the biggest problems to date: the lack of standardization in reporting data. “Only a small number of jurisdictions are placing obligations on market participants relating to non-centrally cleared transactions, such as trade confirmation timelines, portfolio reconciliation and compression, and trade valuation practices,” according to the report.

It also emphasizes another significant reporting issue, access to trade data by cross-border regulators. “Reporting a counterparty’s identity to TRs may be limited by domestic privacy laws, blocking statutes, confidentiality provisions and other domestic laws,” the FSB says. It also urges the jurisdictions to “continue to monitor the development of or changes in such laws and their proposed reporting requirements to ensure that any planned reforms adequately address barriers to reporting OTC derivatives transactions.”

With regard to clearing, the report says, “Jurisdictions must rapidly implement the G20 commitment to centrally clear all standardised products, in order to reduce systemic risk and to minimise risks of regulatory arbitrage between jurisdictions.” It points out three reasons why the clearing mandate hasn’t been completely adopted:

“Insufficient standardization. Some jurisdictions consider that currently there are not sufficiently standardized OTC derivatives products in their jurisdictions for central clearing to be viable.

“Availability of CCPs. Even where standardization is sufficient for central clearing to be viable, some jurisdictions report practical difficulties in implementation because no CCP is accessible by market participants located in their jurisdiction that offers clearing for the OTC derivatives products most actively traded in their markets.

“Use of incentives. Some jurisdictions have indicated that they expect that central clearing of standardized OTC derivatives will occur in their jurisdictions without mandatory obligations, due in part to the various incentives that market participants will face, including, for example, the requirements under the Basel III framework for banks and the margining requirements for non-centrally cleared trades.”

The FSB is skeptical of the reliance on incentives, and urges jurisdictions that do so to “recognise there is a risk that jurisdictions that have applied mandatory requirements may not regard their regime as equivalent. As international work increasingly focuses on implementation monitoring, the FSB will pay particular attention to the risk of regulatory arbitrage resulting from differences in jurisdictions’ implementation of central clearing reforms, across those jurisdictions imposing mandatory obligations and those that have not.”

Finally, on centralized trading, the report recognizes that this is perhaps the most difficult requirement, acknowledging that:

“Only a very small number of jurisdictions have requirements in force in this area. Many jurisdictions indicate that reform efforts are first being focused on implementing reporting and clearing requirements, or that further analysis is required of market liquidity before implementing trading requirements. However, this should not delay the enactment of legislation and regulation that would permit the implementation of trading requirements once they are determined to be appropriate for particular products.”

So the FSB gives the member jurisdictions a barely passing grade in derivatives reform, and, like a diligent teacher sending a note home, “The FSB Chairman has written to all member jurisdictions requesting confirmation that legislation and regulation for reporting to trade repositories are in place, as well as their committed timetables to complete all OTC derivatives reforms. He stressed that the need for prompt action on TRs should not in any way diminish the need for rapid completion of reforms in other areas, such as central clearing, capital and margining, and trading on exchanges or electronic platforms.”

Of course, as any teacher can attest, the parents have to take the warnings to heart or there will be no improvement in the classroom. The big question with this report card is: Will the jurisdictions care, or will they drop it in the trash on the way home?