OTC clearing: A fractured global approach

With not long to go until the Dodd-Frank Wall Street Reform and Consumer Protection Act in the US becomes effective, there still remains great uncertainty as to how regulation of the global OTC derivatives marketplace will finally be implemented.

As it stands, there are inconsistent timeframes between the various OTC clearing regulatory frameworks across the world, which is causing great concern. The G20 Pittsburgh communiqué requires OTC derivatives market reforms to take place no later than by the end of 2012. However, the enforcement of the Dodd-Frank reforms in the US by July 2011 is more than 18 months before the G20’s timetable, as well as that of their Asian and European counterparts. It should come as no surprise then that this tight US deadline is raising numerous questions for market participants. In fact, fears are already growing about US banks becoming uncompetitive compared with European and Asian banks who are not required to comply with the tight Dodd Frank restrictions.

In addition to the diverse deadlines, there are also major gaps between the requirements under each regulatory framework. For example, the Dodd-Frank Act mandates the concept of “Swaps push-out” which has not been adopted by the European Market Infrastructure Regulation (EMIR). This concept requires banks to move certain derivatives activities off their balance sheet and into separately capitalised affiliate entities. This requirement would be a condition for the bank to be entitled to receive various forms of US federal assistance. Such a requirement would significantly disadvantage US banks against their European and Asian counterparts, since their relevant regulatory frameworks are currently devoid of such severe restrictions.

Without consistency across the different geographical markets, there is a danger of ‘regulatory arbitrage’ becoming rife, as market participants select between various alternative jurisdictions to perform a particular type of transaction. Forecasts have been circulating that the derivatives trading activity of some US and EU based banks could migrate to Asia where requirements have not been put in place yet. It is clear then that international consensus is needed both in terms of implementation strategies and timelines if certain regions wish to retain their current status as the leading global financial centres.

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Coming next: Feedback and thoughts on the update from the US Commodity Futures Trading Commissioin (CFTC) showcase on Swaps Execution Facilities (SEFs), chaired by Commissioner O'Malia of the CFTC last week