Sea of ChangeRegulatory reforms – charting a new course

International OTC derivatives reformsChris Bates, Partner, Clifford Chance, London

September 2012

Clifford Chance

Forces shaping regulation of OTC derivatives

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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......

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Market reform

• Clearing*• Trading*• Reporting*• Margining*• Risk

mitigation• Transparency• Licensing

Capital and structure

• Basel III* • Bank structure

(Volcker, US push-out, Vickers, Liikanen)

• Recovery and resolution*

Other

• Uncovered sovereign CDS

• Financial Transaction Taxes

• FATCA• Etc.

The international agenda

*G20 agenda item

3International OTC derivatives reforms

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Sea of ChangeRegulatory reforms – charting a new course

“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

Market reforms – G20 commitments

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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

Simple instructions, complex outcomes

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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

Points of difference

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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

Basel III

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US

• Volcker rule: bans proprietary trading and sponsorship of private funds

• Push out rule: limits OTC derivatives in insured bank

UK

• Mandatory ring fencing of retail deposit-taking activities

• Limits on derivatives activities of ring-fenced entities

EU

• Mandatory subsidiarisation of trading activities (press reports)

Bank structural initiatives

*G20 agenda item

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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

Recovery and resolution

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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

Market outcomes

10International OTC derivatives reforms

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