TWN Info Service on Finance and Development
17 October 2011
Third World Network
Slow pace in implementation of OTC derivatives
SUNS #7238 dated 13 October 2011
Geneva, 12 Oct (Kanaga Raja) - With only just over one year until the
end-2012 deadline for implementing the G20 commitments with respect
to over-the-counter (OTC) derivatives market reforms, few Financial
Stability Board (FSB) Members have the legislation or regulations in
place to provide the framework for operationalising the commitments.
This is the assessment of the FSB in its second six-monthly progress
report on implementation of OTC derivatives market reforms, released
on 11 October.
The report concludes that jurisdictions should aggressively push forward
to meet the end-2012 deadline in as many reform areas as possible.
The FSB, whose secretariat is hosted by the Basel-based Bank for International
Settlements, was established to coordinate at the international level
the work of national financial authorities and international standard
setting bodies to develop and promote the implementation of effective
regulatory, supervisory and other financial sector policies in the interest
of financial stability.
According to the FSB, in September 2009, G20 leaders agreed in Pittsburgh
that, by end-2012, all standardised OTC derivative contracts be traded
on exchanges or electronic trading platforms, where appropriate, and
cleared through central counter-parties (CCPs); that OTC derivative
contracts be reported to trade repositories; and that non-centrally
cleared contracts be subject to higher capital requirements.
The G20 leaders had asked the FSB and its relevant members to assess
regularly implementation and whether it is sufficient to improve transparency
in the derivatives markets, mitigate systemic risk, and protect against
In June 2010, said the FSB, G20 leaders reaffirmed their commitment
to achieve these goals. In its October 2010 report on "Implementing
OTC Derivatives Market Reforms", the FSB had made 21 recommendations
addressing practical issues that authorities may encounter in implementing
the G20 leaders' commitments.
In its first implementation progress report, published in April 2011,
the FSB said it had expressed concern regarding the likelihood of many
jurisdictions meeting the end-2012 deadline set by the G20.
In this first progress report, the FSB further said it had warned that
in order for this target to be achieved, jurisdictions needed to take
substantial, concrete steps toward implementation immediately.
The current progress report comes nearly two years after the Pittsburgh
G20 leaders' summit and just over one year from the end-2012 deadline,
the FSB said.
The FSB report recognizes that the needed laws and regulations are complex
and have the potential to result in significant changes in market structure.
They must be developed with due care and analysis so as not to compromise
the objectives for derivatives market reform set by the G20 of improving
transparency in the derivatives markets, mitigating systemic risk, and
protecting against market abuse.
Nonetheless, the report adds, legislative and regulatory frameworks
need to be put in place expeditiously to establish the parameters and
requirements for the full set of practical actions that firms, markets,
infrastructures, and authorities need to take.
"In the interim, it is critical that market participants continue
efforts to reform the trading, clearing and reporting of OTC derivatives."
According to the FSB, its second progress report provides a more detailed
assessment of progress toward meeting the G20 commitments relating to
central clearing, exchange and electronic platform trading, reporting
to trade repositories, capital requirements, and standardisation.
The FSB said that for each of the G20 commitments, the report provides
an assessment of progress in the three key steps that need to be taken:
the development of international standards and policy; the adoption
of legislative and regulatory frameworks; and actual implementation
through changes in market practices.
With respect to the issue of central clearing, the FSB report notes
that Members remain committed to changing legislative and regulatory
frameworks, as needed, by end-2012 to achieve the G20 commitment to
Some jurisdictions have indicated that they are waiting for the United States
and European Union regulatory frameworks to be finalised before acting.
The report emphasizes that consistency in implementation across jurisdictions
is critical, and it is understandable that smaller markets want to see
what frameworks the United
States and the European Union put in
place when developing their own frameworks.
For instance, some smaller markets want to consider factors such as
oversight arrangements and the availability of infrastructure for indirect
clearing (i.e. clearing for market participants who are not members
of the CCP) before deciding whether to rely on global infrastructure
or promote local clearing infrastructure.
Nevertheless, the report stresses, it is important that all jurisdictions
advance development of needed legislative and regulatory frameworks
as far as they are able even before finalisation of the United States
and European Union regimes, to be in a position to act expeditiously
once rules are finalised in these two largest OTC derivatives markets.
Increasing the central clearing of OTC derivatives in practice is showing
some progress both in higher volumes and expanded products, particularly
in the interest rate and credit asset classes.
Nevertheless, taking this into account together with the pace at which
various jurisdictions are implementing central clearing mandates, the
FSB believes that the target of having all standardised OTC derivatives
contracts centrally cleared will not be fully met by end-2012 in all
FSB member jurisdictions.
"Therefore, the FSB believes that jurisdictions should aggressively
push forward to meet the central clearing deadline for as many standardised
OTC derivatives contracts as practicable."
On exchange and electronic platform trading, the FSB report finds that
the establishment of legislative and regulatory frameworks to implement
the commitment to trading standardised derivatives on exchanges and
electronic platforms, where appropriate, is markedly behind the progress
made toward other commitments.
Only the United States
has enacted legislation and is actively working on the detail of the
While the European Union (through pre-legislative consultation) has
set out the direction of its regulatory framework, it does not anticipate
having legislation in place before 2013.
Most other jurisdictions have not yet made basic decisions about regulatory
measures, including whether any regulatory action will be taken.
The report notes that efforts to set an international standard for what
the organised platform trading commitment means in terms of policy recommendations
culminated in the International Organisation of Securities Commissions
(IOSCO) Report on Trading of OTC Derivatives, which was published in
Although IOSCO is conducting a further detailed stock-take on market
use of multi-dealer versus single-dealer platforms, no further international
policy guidance is anticipated.
Until more is known, the FSB said it is unable to assess whether the
G20 commitment to organised platform trading will be fully achieved
in practice in all FSB member jurisdictions.
"Based on the slower pace of basic decision-making in most jurisdictions,
progress certainly does not appear to be on track across jurisdictions
to meet the G20 commitment to exchange or electronic platform trading,
where appropriate, of all standardised OTC derivatives by end-2012.
Jurisdictions therefore should accelerate decision-making in this area."
On the issue of reporting to trade repositories, the FSB progress report
notes that Members remain committed to putting in place by end-2012
the legislative and regulatory frameworks for achieving the G20 commitment
to reporting to trade repositories (TRs).
However, it underscores, there are a number of implementation issues
that need to be resolved around ensuring the suitability of the data
collected in TRs for meeting different regulatory mandates (including
financial stability) and authorities' effective access to data stored
in TRs relevant to their respective mandates.
Actual reporting of OTC derivatives contracts to TRs is showing progress
in the interest rate, credit, and equity derivatives asset classes.
Currently, TRs are not operational for the commodity and foreign exchange
asset classes, although infrastructure is under development.
Based on the current state of implementation, the FSB believes that,
as is the case with central clearing, the target of having all OTC derivatives
contracts reported to TRs will not be fully met by end-2012 in all FSB
"Nonetheless, the FSB believes that jurisdictions should aggressively
push forward to meet the TR reporting deadline for as many OTC derivatives
contracts as practicable."
With respect to capital requirements, the report finds that Members
remain committed to putting in place by end-2012 the legislative and
regulatory frameworks to achieve the G20 commitment to higher capital
requirements for non-centrally cleared derivatives.
It notes that the Basel III capital framework, which strengthens the
requirements for counter-party credit risk exposures, will take effect
on 1 January 2013. Some aspects of that framework, in particular as
it relates to banks' exposures to CCPs, are still being finalised.
At present, the FSB said it lacks information on capital requirements
for non-bank regulated entities. Going forward, the FSB said it intends
to focus on gathering this information.
According to the FSB report, standardisation is a core element for meeting
the G20 commitments relating to central clearing, organised trading,
and reporting to TRs.
To date, it notes, coordinated industry action led by the OTC Derivatives
Supervisors Group (ODSG) has been the main driver of increased standardisation
through a series of quantitative and qualitative commitments.
The industry's strategic roadmap delivered to the ODSG as part of the
commitment letter published in March 2011 (Strategic Roadmap) establishes
a framework for managing continued improvements in process and product
standardisation by the G14 dealers and other major market participants.
"As establishment of legislative and regulatory frameworks to implement
the G20 commitments progresses, authorities expect the industry to continue
to increase standardisation of OTC derivatives products."
According to FSB, most jurisdictions believe that the proportion of
OTC derivatives that are standardised will have substantially increased
from pre-2009 levels by end-2012.
Approximately half the jurisdictions surveyed have adopted or plan to
adopt legislative and regulatory measures to increase the use of standardised
products and processes, while some other jurisdictions with markets
that are already highly standardised expect to maintain these levels.
The FSB said it has been aware from the outset that there is a risk
that overlaps, gaps, or conflicts in legislative and regulatory frameworks,
if not addressed, could compromise achievement of the G20 objectives.
This could occur if an overlap, gap, or conflict leads to an increase
in systemic risk, or places inconsistent requirements on market participants
that cannot be effectively implemented in practice.
The FSB pointed out that a number of potential overlaps, gaps, or conflicts
have been identified and authorities are working on solutions.
Examples include issues concerning legislative and regulatory frameworks
for regulation and oversight of CCPs and TRs, the application of central
clearing requirements, and requirements by some jurisdictions that clearing
occur in their respective domestic (or domestic-registered) CCPs.
"Work is needed to assess whether the issues that have been identified
imply material problems for implementation at a global, systemic level."
One potential gap, which the FSB said it has identified, concerns the
applicability of the G20 commitments to standardised derivatives that
are moved onto exchanges or electronic trading platforms (and therefore
no longer traded "OTC").
According to the FSB report, survey responses indicate some jurisdictions
continue to review whether to mandate central clearing for these standardised
The FSB said it believes that any interpretation of the language of
the G20 commitment, which refers only to standardised "OTC"
derivatives, to create a loophole so that such derivatives once moved
onto organised platforms do not need to be centrally cleared or reported
to trade repositories is clearly contrary to the spirit of the OTC derivatives
reforms which are aimed at mitigating systemic risk.
The FSB recommended that all jurisdictions should confirm that standardised
derivatives of the types which used to trade OTC should be centrally
cleared and reported to TRs, irrespective of whether they continue to
trade OTC or are moved onto organised platforms.
As to the next steps, the FSB said that a clear challenge going forward
is to effectively monitor implementation through changes in actual market
practice toward achieving the G20 commitments.
"Although improvements already can be seen, the scale of improvements
is difficult to measure because today's OTC derivatives markets have
not yet reached the substantially increased levels of transparency envisioned
by the G20."
In the interim, until reporting to TRs and other reforms have been fully
implemented, the FSB said it needs to identify alternative sources of
data and metrics for tracking progress toward achieving the G20 commitments.
Presenting useful and comparable data tracking actual market changes
is a priority for the FSB monitoring efforts going forward.
In its overall conclusions, the FSB said that it believes that the highest
current priority in implementation of OTC derivatives markets reforms
is to increase the pace of legislative and regulatory action to ensure
that frameworks are in place as soon as possible.
"Jurisdictions should aggressively push forward to meet the end-2012
deadline in as many areas as possible, including accelerating jurisdictional
policy decision-making with regard to organised platform trading."
The European Union and the United
States, the jurisdictions with authority
over the largest and most developed OTC derivatives markets, are well
into the process of establishing legislative and regulatory frameworks.
Many jurisdictions have indicated that final decisions on domestic legislative
frameworks will look to the international baseline established once
European Union and United
States' legislation and implementing
regulations are in place and international standards are finalised.
Only a small minority of jurisdictions either have pre-existing frameworks
or have adopted legislative reforms and are working on implementing
To meet the end-2012 deadline, the FSB stressed that it is important
that all jurisdictions do as much as they can without waiting for finalisation
of approaches in the largest markets.
To ensure consistency in implementation, and avoid overlaps, gaps, and
conflicts in legislative and regulatory frameworks that may risk compromising
reform objectives, specific overlaps, gaps, and conflicts should continue
to be discussed, as a matter of priority, bilaterally between or multilaterally
Solutions also should come through consistency across jurisdictions
in application of international standards that either address such issues
directly or set out processes and expectations for international cooperation
between authorities, says the FSB report.
The FSB said that as a key element of its work going forward, its OTC
Derivatives Working Group will continue to actively monitor the consistency
of implementation across jurisdictions and bring to the attention of
the FSB any overlaps, gaps or conflicts that may prove detrimental to
G20 reform objectives, particularly if there seems to be a risk that
they will not be satisfactorily resolved through existing bilateral
or multilateral channels.
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