Regulation of Over-the-Counter Derivatives (Update)
January 26, 2010
OTC market participants should be aware of ongoing changes in legislation in the United States and Europe with regard to regulation of the OTC derivatives market.In November 2009, McDermott reported on the US House Financial Services Committee’s approval of draft legislation, the Over-the-Counter Derivatives Markets Act of 2009, for the regulation of the over-the-counter (OTC) derivatives market. This legislation is part of an effort to mandate new clearing, trading and reporting rules for the OTC derivatives market in the United States. The full text of the article can be found at:
In December 2009, the US House of Representatives passed the Wall Street Reform and Consumer Protection Act of 2009, including the Over-the-Counter Derivatives Markets Act and several other financial regulatory measures. Voting was almost entirely along partisan lines, with the Republican Party strongly opposing the Act. The legislation is currently being considered by Senate committees and still has some way to go before becoming law. The Senate draft version is largely based on the House version but the Senate is widely expected to take a tougher stance. The text passed by the House of Representatives grants certain exemptions from the new requirements to non-financial users of OTC derivatives – the result of intense lobbying – but the Senate is expected to narrow these exemptions.
Draft legislation is yet to be published in Europe (the European Commission is due to propose a draft law by mid-2010) and OTC market participants are attempting to influence its course. In January 2010, representatives of some 160 non-financial corporate OTC users petitioned the Commission to exempt them from the proposed new European regime. They argued that the collateral requirements imposed by the new regime for cleared derivatives and the capital requirements for those that are not cleared would tie up too much capital; and that this in turn may hamper the recovery of the European economy by depriving OTC users of much needed liquidity.
These arguments may yet find some favour in Europe. Where the US approach is seen as more prescriptive overall, the Commission’s proposals so far (see its July and October 2009 Communications – COM(2009) 332 and COM(2009) 563) are based on broad policy principles with few details of how these will be implemented. The Commission has also indicated that it will implement the new regime only following wider consultation. Nevertheless, the Commission has declared that it does not intend to exempt non-financial corporate users of non-cleared derivatives from collateral requirements, on the grounds that “awarding special treatment for non-financial firms could create loopholes which would enable financial firms to engage in regulatory arbitrage. Any possible exemptions should be designed in such a way that eliminates any potential for abuse.”
In November 2009, McDermott wrote that it remained to be seen whether the OTC derivatives market would become the subject of a regulatory turf war. Market participants are certainly trying to take advantage of the difference in the advancement of the legislative process on both sides of the Atlantic to extract concessions. Whether this ultimately leads to “regulatory arbitrage” between jurisdictions (or “jurisdiction shopping”) or a levelling of the regulation to the lowest common denominator is not yet evident. And whether the United States and Europe ultimately diverge in the details or succeed in taking a “universal” approach, there are indications that other countries are embarking on their own OTC derivatives reforms (Japan and India, for instance), thereby increasing the risk of distortions across the globe.
Meanwhile, the industry has continued its own efforts to improve the functioning of the OTC derivatives market. In January 2010, the International Swaps and Derivatives Association reported on the progress of its and its members’ work for the improvement of the privately negotiated derivatives industry infrastructure, and committed to deliver a further commitment letter to supervisors (including the US Federal Reserve) by March 2010.
If the US legislative process goes according to plan, the next big step in the regulation of the OTC derivatives market will come from the US Senate. It will be interesting to see the shape that it gives to the Over-the-Counter Derivatives Markets Act of 2009.
