Intense industry lobbying may be paying off over the extraterritorial application of upcoming new derivatives rules, with global regulators beginning to take on board growing market concerns by looking to apply more regulatory consistency across borders.
Given the global nature of the over-the-counter derivatives markets, close cross-border supervision is likely to be needed to produce a level playing field that will be suitable for all derivatives users.
Back in 2009, following the onset of the financial crisis, the G20 group of nations demanded that regulators around the world draw up rules that would centralize and manage counterparty credit risk and increase transparency in the opaque OTC derivatives sector, which was blamed for the collapse of Lehman Brothers in 2008.
However, up until now regulators, especially in the U.S. and Europe, which are home to the main global derivatives markets, have adopted slightly different approaches under the U.S. Dodd-Frank Act and Europe’s European Market Infrastructure Regulation (Emir).
“We take the approach that we should avoid breaking up a global market into a number of local ones for the simple purpose of applying our domestic rules,” Steven Maijoor, chair of the European Securities and Markets Authority, the pan-European regulator that is currently in the process of writing the technical standards for Emir, told a conference in Paris earlier this month.
“Europe has long experience of relying on each other’s supervision and in assessing the equivalence of third country systems. These concepts have allowed European financial markets to grow significantly and if we want the global markets to grow as well, we would need to extend these principles at international level.
“On the international dimension of Emir, we are not yet consulting on the technical standards relating to the issue about which transactions outside the European Union should be subject to the Emir requirements. This is an area where we need to co-ordinate with our counterparts outside the EU before consulting on specific proposals.
“Indeed, all these reforms aim at ensuring that derivatives markets continue to serve their purposes of allowing for a proper hedging of risks.”
However, there are still differences in the language regulators across the Atlantic have been using over such things as exemptions, segregation of collateral, trading venues and clearing requirements, as well as Dodd-Frank’s extraterritoriality scope. Some of the standards, though, have yet to be finalized, which is also causing the industry some angst, especially in Europe. Many cross-border institutions are also likely to have to consider both sets of rules.
BNY Mellon, the world’s largest custodian bank, believes that there are still key inconsistencies in the reforms regarding clearing and sovereign wealth funds.
Sovereign institutions, which use capital markets and OTC derivatives for implementing their investment strategies and hedging exposure, are seen in the markets as low-risk counterparties and, as such, have not previously had to provide collateral.
“With global regulatory reforms, however, precisely what is in and out of scope with respect to sovereigns remains murky,” said Jai Arya, head of BNY Mellon's sovereign institutions group.
However, BNY Mellon believes that some progress will be made on extraterritoriality.
"We expect that a common approach will be reached between the major strands of regulatory reform to avoid market distortions and regulatory arbitrage, but inconsistency and conflict between national and supranational rules persists," said Nadine Chakar, head of Derivatives360(SM) at BNY Mellon.
"Until a consistent framework of exemptions from both capital adequacy and clearing requirements across jurisdictions may be agreed, sovereigns may find that their OTC derivatives activities become subject to mandatory clearing."
Last month, a group of trade bodies from both sides of the Atlantic, called the EU-US Coalition on Financial Regulation, warned in a report that the current regulatory stances of Europe and the U.S. were encouraging legal risk, compliance complexity, regulatory uncertainty and added transactional costs in an increasingly fragmented approach. The coalition is demanding greater co-operation on regulatory policies, objectives, standards and outcomes.
“You are seeing growing strands of regulatory extraterritoriality—we are in a world of clashing rules,” Anthony Belchambers, chief executive of the Futures and Options Association, a European trade association for the derivatives market, told Markets Media last month.
