Since the US financial reform package, formally the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), which became law on 21 July 2010, the CFTC has put forward 18 final rules. The CFTC have already proposed rules on regulation of dealers. There are various rules on clearing and trading mandates. The purpose of the rules on clearing and trading is to reduce risk by moving “standardised“ derivatives onto clearing houses and to execute standardised swaps with more pre-trade transparency. The provision on trading oversight and market transparency includes regulation of swaps trading platforms (swap execution facilities (SEFs) and designated contract markets (DCMs)) and various post-trade transparencies. The provision on transparency to regulators includes reporting data on swap trades to regulated swap data repositories (SDRs), which are required to register with the CFTC, or reporting data directly to the Commission if there are no SDRs accepting the data. The final key element of the Act is the position limit on certain commodities.
The European Commission also issued several communications regarding commodity markets and raw materials. The first vehicle related to energy markets is the regulation of wholesale energy market integrity and transparency, so called REMIT, published in July 2011. The REMIT aims to prevent market abuse and manipulation in wholesale energy markets and to increase transparency for trading on those markets (See more on REMIT). The European Commission issued three proposals on financial markets that have an impact on commodity derivatives. The first deals with the regulation of OTC Derivatives (European Market Infrastructure Regulation (EMIR)). On 15 September 2010, the European Commission published its final proposal, which sets out to increase stability within OTC derivative markets by introducing a reporting and clearing obligation for eligible OTC derivatives as well as common rules for central counterparties (CCPs) and for trade repositories. The second proposal, published on 20 October 2011, aims to update and strengthen the existing framework to ensure market integrity and investor protection provided by the Market Abuse Directive (MAD). The third proposal deals with the transparency and oversight of the financial markets in the European Union (Markets in Financial Instruments Directive (MiFID), with final proposals also published on 20 October 2011. Specifically, proposals call for standardisation of all OTC derivative contracts traded on organised venues, narrowing of exemptions for commodity firms in line with G-20 commitments, creation of a new trading venue category (“organised trading facility – OTF”), more transparency of trading, including pre- and post-trade transparency, a position reporting obligation by type of participants, and position limits or some other type of position management.
The main goal of these reform packages is to increase transparency and efficiency of the OTC derivatives markets and to reduce potential counterparty and systemic risks. However, as pointed out by the Financial Stability Board (FSB), clear signs have emerged that substantial cross-border differences in the pace of implementation, as well as differences in some rule-making areas, might lead to regulatory arbitrage, in which market participants will seek out lighter-touch jurisdictions, thereby shifting risk rather than mitigating it.
In order to increase market transparency in OTC markets, new proposed rules call for:
While the US and EU’s proposed rules on transparency are similar, there are certain differences that might lead to regulatory arbitrage. For example, as opposed to the strict CFTC proposal that swap execution facilities be either order-book or request-for-quote (RFQ) facilities, the EU has proposed a looser definition of these platforms, which it calls ‘organised trading facilities’, which do not require order-book or RFQ facilities. This might create regulatory arbitrage opportunities, prompting banks to shift activity from the US to Europe to take advantage of a laxer regime.
Market participants have already raised concerns over some of the issues in the rules related to transparency. Their main concerns include the following:
The second purpose of the financial reforms is to lower inherent risk in the OTC market. In order to lower the risks, new rules call for:
Critics argue that some of the proposed regulations might have unintended consequences in the market place. These include:
Regulatory efforts to increase transparency and reduce systemic risks in global OTC markets have intensified in the last year. Some observers have argued that the CFTC has rushed to meet arbitrary deadlines without properly analysing the costs and benefits of new rules for swaps markets. However, despite the rapid pace of rule-making, the US missed the July 2011 deadline for the implementation of the rules under the Dodd-Frank Act. Slow progress on agreed reforms to meet the end of 2012 deadline set by the G-20 in Pittsburgh in 2009 is seen as another problem, notably the apparent lack of international consensus between regulators on how to achieve the key elements of the reform agenda. Regulatory arbitrage opportunities might undermine the impact of new regulations even in countries where more stringent rules are to be implemented. Therefore, more international coordination is needed for more consistent and effective oversight in OTC markets.(See my blog on cross-country differences in OTC market regulations)
|Dodd-Frank Act (CFTC)||My Blog|
|European Commission||Street Professor (Craig Pirrong Blog)|
|IOSCO||Market Reforms Wiki|
|FIA||My Facebook Page on Regulations|