by Craig Donner
Although regulators in the U.S., Europe and Asia are still months away from finalizing new rules to govern the over-the-counter (OTC) derivatives market, they need to begin working now on harmonizing regulations globally to prevent regulatory arbitrage, warned Larry Thompson, DTCC general counsel, during two recent speeches on derivatives reform.
Thompson spoke at SunGard’s New York City Day 2011 on pre- and post-trade implementation of Dodd-Frank and regulatory reform. He also delivered the keynote address at a conference sponsored by Financial Markets World on derivatives. At both events, Thompson said the recent public jousting between officials in the U.S. and overseas suggests that regulators have potentially divergent views on how to formulate a new regulatory regime, which creates the potential for unintended negative consequences.
Thompson pointed to the indemnification provision of Dodd-Frank, which requires U.S.-based swap data repositories (SDRs) to obtain indemnification agreements from foreign regulators prior to sharing critical market data with them. Thompson said it is unlikely that European regulators would indemnify U.S. entities because the extraterritorial mandate is inconsistent with traditions and legal structures in Europe.
“The fact is, this makes little sense in the global derivatives market, especially because many regulators are already following policies and procedures to safeguard and share data based on guidelines established by the OTC Derivatives Regulators Forum,” Thompson said. “If the provision is not revised or eliminated, it has the potential to undermine the ability of regulators and market participants to obtain a comprehensive and unfragmented view of the global marketplace. As a regulator, if you can’t see the whole market, you can’t see the potential for systemic risk.”
Thompson also noted that the European Parliament is poised to adopt counterindemnity language in the final version of its own reform regulation – a position that is consistent with recent comments by Michel Barnier, the European Union’s financial markets commissioner, who said that while he wants to make sure Brussels and Washington are acting “in parallel,” he would push for reciprocity if there isn’t sufficient convergence.
Thompson added that some members of Congress have already begun outreach to their European counterparts to seek a resolution. In addition, he said the issue is on the radar of Chairman Gary Gensler of the Commodity Futures Trading Commission (CFTC) and Chairman Mary Schapiro of the Securities and Exchange Commission (SEC).
Gensler recently testified that the agencies recognize the provision is problematic and he suggested two potential exemptions to its enforcement. The first exemption would apply when a foreign regulator (third party) requests data from a repository that has dual registration with regulators in the U.S. and overseas.
The second would apply when a foreign regulator (third party) seeks to obtain information that is held by the CFTC or SEC.
However, Thompson said that the legal language in Dodd-Frank leaves little room for the regulators to work without Congressional intervention – and the exemptions, while well intentioned, do not solve the problem and that more needs to be done.
Thompson noted that in addition to the repository DTCC created and operates for the global OTC credit default swap (CDS) market, it has been selected by the International Swaps and Derivatives Association (ISDA) to build the global equity derivatives repository, which will be headquartered in London, as well as the first global repository for commodities swaps trades, in collaboration with European trading services provider EFETnet. (See article on the FX repository.)
“Market participants seem to be coalescing around the concept of trade reporting as a non-commercial function that’s best carried out by a utility,” Thompson said. “We view trade reporting as a pure regulatory and public-policy function, and we see our role as supporting the industry and regulators in meeting the requirements of the new law. In addition, our organizational structure has contributed to our ability to connect with all market participants and to ensure robust and secure systems. Also, market participants recognize the significant cost savings of leveraging a common infrastructure that’s already built and operating efficiently, and they understand the value of DTCC’s deep global experience and very successful track record operating a trade repository.”@