Sea of Change
Regulatory reforms – charting a new course
International OTC derivatives reforms
Chris Bates, Partner, Clifford Chance, London
September 2012
Forces shaping regulation of OTC derivatives
Regulation is being shaped by several
powerful forces
 The financial crisis
 The euro crisis
 The G20 agenda

Global rebalancing
 Competition policy
 Politics
 Differing views from global
regulatory bodies
The effects are beginning to profoundly alter
the shape of the OTC derivatives market
There is a lot of legislation and still a long
way to go......
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The international agenda
Market reform
Capital and
structure
Clearing*
Trading*
Reporting*
Margining*
Risk
mitigation
• Transparency
• Licensing
• Basel III*
• Bank structure
(Volcker, US
push-out,
Vickers,
Liikanen)
• Recovery and
resolution*
•
•
•
•
•
Other
• Uncovered
sovereign
CDS
• Financial
Transaction
Taxes
• FATCA
• Etc.
*G20 agenda item
International OTC derivatives reforms
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Sea of Change
Market reforms – G20 commitments
Regulatory reforms – charting a new course
“All standardized OTC derivative contracts should be traded on
exchanges or electronic trading platforms, where appropriate, and
cleared through central counterparties by end-2012 at the latest. OTC
derivative contracts should be reported to trade repositories. Noncentrally cleared contracts should be subject to higher capital
requirements.”
G20 Pittsburgh, September 2009
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Simple instructions, complex outcomes
 Obligation for counterparties to clear eligible OTC derivatives with registered central
counterparties (CCPs)
 Obligation to execute eligible transactions through a trading system, not bilaterally
 Obligation to report all transactions to a registered trade repository
 Obligation to collect/post initial or variation margin on uncleared transactions
 Regulation of confirmation process, portfolio reconciliation, trade compression and client
documentation
 Pre- and post-trade transparency for OTC transactions
 Position limits/position management powers for commodity derivatives
 Licensing or registration requirements for dealers and systemically important end-users
 Business conduct rules for market participants, extension of market abuse rules
 Regulation of CCPs and trade repositories
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Points of difference
Different pace of reform around the world
 US, EU, Asia
 Clearing, reporting, margining vs. trading, transparency
Scope issues
 Instruments: e.g. FX, physical commodities and securities
 Entities: e.g. treatment of end-users, intra-affiliate trades, pension funds, central banks
Margining of uncleared trades
 Initial margin and collateral thresholds
Extraterritoriality and overlapping, conflicting rules
 Different approaches to territorial nexus e.g. location of counterparties, arranger,
transaction underlying
 Extra-territorial application of licensing rules
Regulation of CCPs and trade repositories
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Basel III
Basel III supplemented by national initiatives to raise bank capital
 EU and US stress tests
 Additional capital buffers e.g. UK, Sweden, Austria, Switzerland
More, better quality capital and enhanced deductions from capital
 Focus on equity and additional buffers, including G-SIB buffers
 Plus unweighted leverage ratio
Increased risk weights for assets affect OTC derivatives
 CVA: credit valuation adjustment
 Additional capital charge for exposures to large financial institutions
 Capital charges for client business cleared with a CCP
 Trading book review
Liquidity risk regulated through liquidity coverage ratio and net stable funding ratio
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Bank structural initiatives
US
• Volcker rule:
bans proprietary
trading and
sponsorship of
private funds
• Push out rule:
limits OTC
derivatives in
insured bank
UK
• Mandatory ring
fencing of retail
deposit-taking
activities
• Limits on
derivatives
activities of ringfenced entities
EU
• Mandatory
subsidiarisation
of trading
activities (press
reports)
*G20 agenda item
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Recovery and resolution
International convergence of resolution regimes
Financial Stability Board publishes key attributes
Requirement for recovery and resolution planning
 Possible resulting structural changes to banks to facilitate resolution
Recognition that ordinary insolvency regimes inadequate for systemically important
institutions
 US FDIC/orderly liquidation regime, UK Banking Act, German regime, EU proposed
directive
Debate over the role of “bail-in” as a resolution tool
 Write down of junior and senior liabilities or conversion into equity
 Impact on derivatives
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Market outcomes
Restriction on banks’ derivatives capacity
 Client and bank response may result in regional booking silos
 Reduction in product range
 Increased barriers to entry for smaller market participants
Increasing importance of CCPs
 Focus on financial stability issues and market structure
Possible new market entrants: “shadow banks”
Winners and losers
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