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Moves Underway to Globalise Regulatory Framework

Colin Lambert reports on efforts to establish a unified framework for regulation. 

As global regulators continue to
work through the process of
creating a new regulatory
structure, there seems to be movement on
one of the overriding concerns of both
industry and regulators – the opportunity
for regulatory arbitrage.

Following the announcement of a
cooperation between the US Commodity
Futures Trading Commission and the
European Commission earlier this year
(Profit & Loss, July/August), the
authorities responsible for OTC
derivatives market oversight in Australia,
Brazil, the European Union, Hong Kong,
Japan, Ontario, Quebec, Singapore,
Switzerland and the United States have
issued a report regarding common
understandings to improve the cross-
border implementation reforms.

The report responds to an April 2013
request by the G20 finance ministers and
central bank governors that key OTC
regulators intensify their efforts to address
and resolve remaining cross-border
conflicts, inconsistencies, gaps and
duplicative requirements.

The report reflects a number of
“substantive understandings” to improve
the cross-border implementation of OTC
derivatives reforms. Specifically, it says
that early and comprehensive consultation
among the relevant authorities when
equivalence or substituted compliance
assessments are being undertaken is

The authorities also say that a flexible,
outcomes-based approach should form the
basis of final assessments regarding
equivalence or substituted compliance
assessments, and that a “stricter-rule”
approach would apply to address gaps in
mandatory trading or clearing obligations.
The latter is seen very much as a victory
for the CFTC to establish its standards

The report also says that the authorities
have a framework for consultation on
mandatory clearing determinations and
that jurisdictions should remove barriers
to reporting to trade repositories by
market participants and to access to trade
repository data by authorities. The latter is
again seen as a victory for CFTC which
has previously stated that as part of its
oversight of US markets it needed to be
able to access information on US
institutions and individuals from offshore
jurisdictions, and will require domestic
law changes in countries such as Australia
which currently has privacy laws banning
such disclosure.

The report also says the authorities
agree that there should be appropriate
transitional measures and a reasonable but
limited transition period for foreign
entities to implement OTC derivatives

The report also recognises that
challenges will continue to arise in the
implementation of OTC derivatives
reforms and presents a number of
additional topics for further discussion,
including authorities’ direct access to
registrant information and the treatment of
foreign bank branches and guaranteed

Finally, the report recognises that open
communication is vital to ensure there is
common understanding of each
jurisdiction’s processes and timelines to
implement OTC derivatives reforms, and
that flexibility in the application of cross-
border regulation will be needed to make
progress toward cross-border consistency.

Market Reaction

The G20 announcement followed
closely a release from the International
Swaps and Derivatives Association
(ISDA), which released a set of principles
it believes will help drive “the widely held
goal of a more harmonised framework of
international derivatives regulations”.

The principles incorporate views
expressed by international regulators and
market participants, and are intended to
guide the development of frameworks and
processes for inter-jurisdictional
recognition of derivatives regulation
through a principles-based substituted
compliance methodology, ISDA says.

The proposals are that an effective
framework should be grounded in the
declarations issued by the G20 following
the Pittsburgh and Cannes meetings;
regional and national regulators should
evaluate the other’s regimes to allow for a principles-based approach to cross-
border compliance and for purposes of
substitute compliance or equivalence,
comparisons of one jurisdiction’s
requirements to another’s may use a
variety of analytical methods, all of which
must start with identification of a set of
common principles that elaborate on the
G20 regulatory goals.

The association continues, arguing that
ultimate decisions regarding comparability
require not only a bilateral dialogue
between regulators, but also a transparent
process; and closes by calling for
regulators to consult and co-operate with 
each other before implementing their
derivatives regulations.

ISDA says it welcomes the recent
initiative by IOSCO in this area and the
announcement of that body’s Task Force
on Cross-Border Regulation. ISDA says it
believes that IOSCO can play “a vital
role” in facilitating bilateral or multi-
lateral inter-jurisdictional recognition
efforts which will greatly help markets to
progress to a consistent international
framework that avoids duplication or
jurisdictional over-reach.

“ISDA undertook the development and
implementation of these principles for
developing substituted compliance
methodology to further the goal that we
believe everyone shares: a coherent,
effective and harmonised international
regulatory framework,” says Stephen
O’Connor, ISDA chairman. “Inter-
jurisdictional recognition of and
consistency in derivatives regulation is
essential in building safe and efficient
financial markets.”

Moves Economically Beneficial

Separately, a new report from the
Macroeconomic Assessment Group on
Derivatives (MAGD) says that the
proposed reforms of OTC derivatives
markets will provide a net economic
benefit of 0.12% GDP per year.

The MAGD was set up by the OTC
Derivatives Co-ordination Group,
comprised of the chairs of the Basel
Committee on Banking Supervision, the
Committee on the Global Financial
System, the Committee on Payment and
Settlement Systems, the Financial
Stability Board and the International
Organization of Securities Commissions.
It comprises financial and economic
modelling experts from 29 central banks
and other authorities, chaired by Stephen
Cecchetti, economic advisor of the Bank
for International Settlements.

In its report, the MAGD focuses on the
effects of mandatory central clearing of
standardised OTC derivatives, margin
requirements for non-centrally cleared
OTC derivatives and bank capital
requirements for derivatives-related
exposures. It notes, “While these reforms
have clear benefits, they do entail costs.
Requiring OTC derivatives users to hold
more high-quality, low-yielding assets as
collateral lowers their income. Similarly,
holding more capital means switching
from lower-cost debt to higher-cost equity
financing. Although these balance sheet 
changes reduce risk to debt and equity
investors, risk-adjusted returns may still
fall. As a consequence, institutions may
pass on higher costs to the broader
economy in the form of increased prices.”

In its “preferred” scenario, the group
found economic benefits worth 0.16% of
GDP per year from avoiding financial
crises. It also found economic costs of 
0.04% of GDP per year from institutions
passing on the expense of holding more
capital and collateral to the broader
economy. This results in net benefits of
0.12% of GDP per year. The group has
published three scenarios, in addition the
aforementioned “preferred” or central
scenario it finds that a low cost scenario,
where netting is at a high level, the benefits 
are again 0.16% per annum and the costs
are 0.3%. In a high cost scenario, with low
netting, the benefit is again 0.16%, but the
cost rises dramatically to 0.9%.

The group stresses that these are
estimates of the long-run consequences of
the reforms, which are expected to apply
once they have been fully implemented
and had their full economic effects. 


Paul Gogliormella

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