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Christopher Bernard | Bloomberg Law
On 29 February, the Technical Committee of the International Organization of Securities Commissions (IOSCO) published a report (Report) setting out recommendations that regulatory authorities should follow when establishing mandatory clearing regimes for over-the-counter (OTC) derivatives contracts in their jurisdictions. The Report addresses a number of key areas, including:
Mandatory Clearing of OTC DerivativesIn September 2009, the G-20 leaders announced a set of initiatives in response to the financial crisis, including a commitment that all standardised OTC derivatives contracts should be cleared through central counterparties (CCPs) by the end of 2012.1 The Financial Stability Board (FSB) published a report in October 2010 in which it made a number of recommendations regarding the implementation of mandatory central clearing. Among other things, the FSB recommended that IOSCO, working with other authorities as appropriate, co-ordinate the application of central clearing requirements for products and participants, and any exemptions from them, in order to minimise the potential for regulatory arbitrage.2 Since then, lawmakers around the world have been busily redrafting rulebooks in an effort to comply with the G-20's commitments, but as the deadline for centralised clearing looms, concerns have been increasingly voiced regarding the timing, quality, and cross-border operability of the various proposals.3 In October 2011, the FSB released a second progress report assessing the implementation process, in which it recognised the work being undertaken but noted that few legislative and regulatory frameworks for mandatory clearing were in place and that different approaches seemed to be emerging.4 Section 723(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act 2010, Pub. L. No. 111-203, § 124 Stat. 1376 (Dodd-Frank), which was adopted in July 2010, established the legislative framework for mandatory clearing in the U.S., but the Commodity Futures Trading Commission (CFTC) is still in the process of finalising rules to implement these requirements.5 In February 2012, after months of negotiations, the European Parliament and Council finally agreed the text of the European Market Infrastructure Regulation, or "EMIR," establishing the legislative framework for mandatory clearing in the EU;6 the European Securities and Markets Authority (ESMA) is now tasked with drafting implementing rules and is months behind schedule.7 The Report was prepared by the IOSCO Task Force on OTC Derivatives Regulation in response to the FSB's 2010 recommendations. It is intended to provide guidance to national authorities in order to promote co-ordination and reduce the potential for regulatory arbitrage.
Determination of Products Subject to Mandatory ClearingThe Report recommends that authorities have an ongoing ability to determine mandatory clearing obligations so that they can respond to market developments as OTC derivative products emerge and evolve. Distinction is made between "determining authorities," which have the power to mandate central clearing, and "supervising authorities," which can authorise a CCP to clear a particular product, though in many jurisdictions one authority performs both functions. As the Report acknowledges, a number of jurisdictions are employing a combination of bottom-up and top-down approaches in making these determinations.8Under the bottom-up approach, products cleared by CCPs are made subject to mandatory clearing by the relevant authority, whereas under the top-down approach, the authority makes products subject to mandatory clearing regardless of whether they are already cleared by CCPs. — Bottom-up Approach The Report recommends that relevant authorities use the bottom-up approach, if allowed by their legislative framework, and outlines a process whereby:
ExemptionsIn some cases, it may be appropriate for regulators to tailor exemptions from the mandatory clearing obligation, provided the exemption does not create systemic risk and is regularly monitored and reviewed. The Report identifies three types of exemptions:
Communication among authoritiesThe Task Force encourages authorities to communicate with each other regarding the implementation of mandatory clearing regimes in their own jurisdictions, both during initial assessment and on an ongoing basis, in order to promote consistency while reducing the risk of regulatory arbitrage. The Report identifies several key areas for transparency:
Cross-border Co-ordinationGiven the global nature of the OTC derivatives markets, gaps, overlaps, or inconsistencies between mandatory clearing regimes could have a significant impact on market participants engaged in cross-border transactions. The Report suggests that authorities co-operate on a bilateral and multilateral basis to address these risks. In some cases, it may be necessary or desirable for an authority to permit third country CCPs to clear transactions in its jurisdiction. Some regimes already allow for this through a distinct form of authorisation or by mutual recognition of the third country regulatory framework. However, the authority may have limited oversight or power to intervene in respect of third country CCPs, which could cause concern if, for example, those CCPs clear products that are systemically important in the authority's jurisdiction. One way to address this risk is for the third country regulators to confirm that risk management of those products is carried out in line with appropriate regulatory standards and for co-operative oversight arrangements to be put in place. Alternatively, contractual or operational links could be established between CCPs. While these are currently being considered, they are unlikely to be in place by the end of the year. In January, the FSB announced the establishment of the OTC Derivatives Co-ordination Group, which is intended to co-ordinate implementation of international reforms.14
Monitoring of Mandatory ClearingThe Report recommends that, once mandatory clearing regimes are established, authorities have effective mechanisms in place to monitor compliance with clearing obligations and exemption requirements and ensure that the regulatory framework remains fit for purpose as markets evolve. Information will be required from a variety of sources, and reporting obligations and regime changes should be clearly communicated to the market.
ImplicationsThe recommendations of the Task Force represent a sensible approach to the need for global co-operation in the implementation of mandatory clearing regimes. U.S. and EU regulators have already recognised this imperative and have been actively involved in the efforts of the Task Force and other multilateral initiatives.15 Achieving these objectives, however, is no easy task. Even with the best intentions, there may be unintended consequences. The devil is in the detail. DisclaimerThis document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.
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