Post-trade transparency in the CDS market

The International Organization of Securities Commissions has published a final report, Post-Trade Transparency in the Credit Default Swaps Market. It analyses the potential impact of mandatory post-trade transparency in one particular over-the-counter (OTC) derivatives market – the credit default swaps (CDS) market. The new post-trade transparency measures include making the price and volume of individual transactions publicly available.

 IOSCO encourages each member jurisdiction to put in place these measures, and recognises that each member jurisdiction is autonomous to decide the appropriate time and manner for enhancing post-trade transparency for CDS that trade in its respective market.

IOSCO media release

Bank of England issues consultation on a new sterling money market data collection and SONIA's reforms

The Bank of England has today published a consultation document setting out in detail plans for a new sterling money market data collection.  The consultation describes how the Bank plans to use these data to reform the Sterling Overnight Index Average (SONIA) benchmark interest rate. SONIA is a basis for British interest rate futures, which investors use as a guide to future moves in interest rates. 

The aim is to secure and improve the information available to the Bank on conditions in sterling money markets. ‘The Bank intends to collect transaction-level data from banks, building societies and major investment firms on their secured and unsecured sterling money market borrowing activity.  This will provide the Bank with a better understanding of developments in short-term interest rates, benefiting the Bank’s analysis of both monetary and financial conditions.  It will also provide a richer picture of activity in the sterling money market, enabling the Bank to better assess overall market effectiveness’. 

As announced by the Bank, 'the consultation sets out, at a high level, the Bank’s plans to reform SONIA, a key overnight unsecured interest rate benchmark.  These plans are likely to be of interest to users of SONIA, including participants in the sterling Overnight Indexed Swap (OIS) market'. 

The Bank and the Wholesale Market Brokers’ Association (WMBA) – which currently administers SONIA – are working towards the Bank taking over as administrator of SONIA in early 2016 so that, in due course, SONIA can be transitioned to a new broader basis. 

The BoE will consult on the planned changes until October 1st. It intends to implement changes following a second round of consultation. The Bank anticipates that it will be in a position to consult on detailed plans for the reform of SONIA in the second quarter of 2016. 

News Release

FSB publishes its ninth progress report on implementation of OTC Derivatives Market Reforms

The Financial Stability Board (FSB) published today its ninth progress report on implementation of OTC derivatives market reforms.

G20 Leaders agreed in 2009 to a comprehensive reform agenda for these markets, to improve transparency, mitigate systemic risk, and protect against market abuse.

To achieve these objectives, the G20 agreed that:

• all OTC derivatives contracts should be reported to trade repositories (TRs);
  
  
• all standardised contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties (CCPs);
  
  
• non-centrally cleared contracts should be subject to higher capital requirements and minimum margining requirements should be developed.
  
  

In summary this report  presents the terms of fully operationalising regulatory frameworks: 

• 'Implementation of reforms is most advanced for trade reporting and for higher capital requirements for non-centrally cleared derivatives. 

• There has been further incremental progress to promote central clearing of standardised OTC derivatives: as at end-June 2015, seven jurisdictions are actively assessing their markets against criteria to determine if certain products should be required to be centrally cleared, and five jurisdictions have central clearing requirements in effect for one or more specific product types. Over the next year, further progress is anticipated in many jurisdictions for assessing if certain products should be required to be centrally cleared. 

• Four jurisdictions have regulatory frameworks in place to promote execution of standardised contracts on organised trading platforms; a few other jurisdictions anticipate taking steps in this reform area over the next year, with several jurisdictions noting that current market conditions do not support further steps. 

• Most jurisdictions are only in the early phases of implementing the BCBS–IOSCO framework for margin requirements for non-centrally cleared derivatives (internationally agreed phase-in periods were recently delayed, and now begin in September 2016). 

• Availability and use of trade repositories (TRs) and central counterparties (CCPs) continues to expand, and these infrastructures are most established for credit and interest rate derivatives. Challenges, such as authorities’ ability to access, use and aggregate TR data, persist. 

Authorities continue to note a range of implementation issues, though international workstreams that aim to address most of these issues are underway, including: steps to harmonise transaction reporting and to agree to a framework for uniform trade and product identifiers; further coordinated consideration of CCP resilience, recovery and resolution, and interdependencies; and ongoing multilateral and bilateral discussions to address cross-border regulatory issues (with several additional steps recently taken by authorities in this regard).' 

The FSB will continue to monitor and report on OTC derivatives reform implementation progress, including the effects of OTC derivatives reforms over time. 

OTC Derivatives Market Reforms Ninth Progress Report on Implementation 24 July 2015

The fifth birthday of Dodd-Frank: ISDA's assessment

During the course of this week several articles have appraised and criticised the five years of implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). This post highlights the ISDA's assessment of the implementation of the Dodd-Frank Act, particularly the rules governing the derivatives market. 

Some of the key requirements and fundamental changes that have been implemented the derivatives market as a result of Dodd-Frank Act include clearing of standardized derivative products, the trading of mandatory products on regulated foreign exchanges or swap execution facilities, reporting of derivatives products to a swap data repository. The US  is in the final stage of implementing the margin for uncleared derivatives, and the implementation of tougher capital rules is on the way.

Some of the reported advances are:

1. In clearing there has been a tremendous success, the industry has readily adapted to a new clearing environment. Approximately the 75% of interest rate derivatives today, and 75% of CDS index daily notional was cleared on average in the first half of this year.

2. In the trading space roughly 75% of interest rate swaps and 59% of CDS index daily notional were traded in the first half of this year.

3. With regard to reporting, all swaps transactions involving a US person are required to be reported to a US trade repository according to the CFTC rules, that’s been going on for two years. The reporting rules give regulators the ability to drill down to the individual trade or counterparty level and, in theory, regulators should be able to aggregate this, in order to observe broader trends and concentrations in the market that might pose systemic risk.

4. In regard to the margin of uncleared products, there is a global margin framework that was proposed in September 2013. That is the good news because major jurisdictions have worked together to establish a consistent OTC margin framework. Both the US and Europe are in the final stages on implementing a final national margin requirements. 

5. The Basel Committee has also developed the capital rules in the international level. Reforms include higher and better quality capital, new liquidity requirements and leverage ratios. The Basel Committee has set up a tight schedule between 2013 and 2019 that means that some of the capital rules are in place today and some of them are still coming into place.

After the GFC, the US was the first mover while other jurisdictions moved in a different pace. Undoubtedly, that  posed some challenges, legislation was drawn up and not much time was given to coordination among supervisors. The differences in the content of different national rules are now beginning to emerge and see the results of that. The immediate effect is that rather to be subject to multiple and inconsistent requirements, derivatives users are increasingly choosing to trade with counterparties within its own jurisdiction.  The result is a fragmentation of liquidity along geographic lines. Therefore, greater harmonisation of the national rules is required, and more transparent process of determining the equivalence would be useful.

The Contribution of ISDA 

ISDA has a global footprint, and that why it has been attacking these issues kind of individually and establishing broader principles to help to solve the different challenges with the each of the rule making.

1) Reporting: Currently regulators are not able to see the global picture of the global risk exposures and possible concentrations due to the differences in reporting requirements in each jurisdiction and across borders. ISDA published principles for reporting that underline the path forward to resolve this issue. 

Regulators across the globe need to identify and agree the trade data they need to fulfil their supervisory responsibilities, and then to tackle the issue of consistent reporting requirements within and across jurisdictions. In the US, for example, there are differences between the CFTC implemented rules and CFTC proposed rules. In addition there are also differences between the US rules and European Rules. The industry would like to see all those rules harmonised in a global framework probably through IOSCO, which would be the best venue for that.

There are also challenges at the legislative level. The Dodd-Frank passed by the US congress includes a provision that requires SDR to indemnify other parties in receiving data, that has preventing the US swap trade repositories from sharing data with anybody other than the CFTC, and has slowed down the process of doing a critical analysis and sharing the data globally. The industry is in a key position to work with regulators to develop and adopt standard products and transaction identifiers as well as clear reporting formats. ISDA has played leading role in this area by creating unique identifying services to give universal market identifiers to market participants.

2) In the Trade execution space ISDA has also played a role looking into the future. It has identified some of the problems that will occur with the differences between the US and the European trading rules to be implemented in early 2017, in addition to future rule making that might be come out of Asia. ISDA has targeted some of the US rules and has helped to harmonise with other jurisdictions rules to have a better cross-border trading. 

For instance, ISDA argues that there is a need to allow more flexible execution rules. The CFTC is taking a very restrictive approach in comparison to the interpretation of the European regulators. Particularly, for the imposition of mandatory trading requirements, ISDA advises that the CFTC should conduct a public consultation where members of the industry can have a voice.

3) Clearing: the main issue is that the European Regulators have not recognized the equivalence of US CCPs, and that fractures liquidity. CCPs have become systemically important and more work is needed to ensure that they are resilient. Moreover the attention should be on increasing transparency in the market, working on margin methodologies, and establishing minimum standards for stress tests. Regulators have done phenomenal works in terms of harmonising the global standards around CCPs but more work can be done. 

ISDA is tackling the issue of recovery of Central Counterparts CCPs, it is focused on making them resilient, robust, capitalised and protected entities, rather than resolvable institutions.  ISDA has published principles on the recovery of CCPs including some ideas around stress testing and transparency in the margin methodology. 

4) In regard to margin ISDA appreciates the efforts by regulators to harmonise these rules in a global basis and the recognition that the more time is needed to implement this effort by extending the compliance date to September 2016 from December 2015. The margin requirement will involve substantial efforts to all the documentation, technology and best practices. 

ISDA has been leading the industry implementation effort for example through the development of the Standard Initial Margin Model, which is a common calculation for computing initial margin requirements for all market participants, this will reduce the potential for disputes. However, in order to progress in that effort the industry needs to know the final rules of initial margin calculation. 

Despite the regulators work to harmonise these rules, there are some differences. For example a proposal from US prudential regulators to subject transactions between affiliates in financial groups to additional margin requirements, is putting the US financial institutions in a competitive disadvantage internationally.

5) With regard to capital a lot of work has been done to implement the capital rules, this should be globally consistent to prevent financial and non-financial institutions being put in a competitive disadvantage. 

There are some differences in the approach of national prudential regulators. ISDA calls for a coherent regulation that is appropriate for the risk of the given activity. It recognises the difficulties faced by regulators who are implementing all these rules at the same time, and trying to understand the ramifications of them. These rules need to be consistent,  work together and operate across both cleared and uncleared markets.  The interplay between the various regulatory components should be comprehensively assessed to ensure that the cumulative impact is fully understood, to avoid excessively high financial costs for borrowers and increasing the cost for end users. At the end of the expectation is to ensure that these markets are viable, that people can continue to use them in a very transparent and open way, and prudently manage their risk. If these rules are too expensive people will not hedge their risk, will not utilise these services and end up holding more risk in their balance sheet.

The market has been adjusting to the new regulatory framework and many of these important technologies and new service providers swap trade repositories, swap dealers, major swap participants have been in limbo for the entire time as to what the standard is.


ISDA

DerivatiViews: Dodd-Frank: The Five-Year Appraisal. July 22, 2015

Dodd-Frank Five Years On: Significant Progress and Outstanding Challenges

The Bank of England's approach to the supervision of CCPs interoperability arrangements

As a result of the post-Global Financial Crisis' reforms many securities and derivatives markets introduced Central Counterparties (CCPs). The rationale of the change in market infrastructure is that the CCP inserts itself between both trading counterparties, to protect them from the risk that one defaults before the obligations are settled. CCP interoperability is an arrangement that links different CCPs, allowing participants of one CCP to deal with participants of another CCP. This can make it cheaper for traders to participate in a wider range of financial markets, and can facilitate competition between CCPs by opening up participant networks. However, interoperability also introduces financial stability risks, primarily by creating dependencies between the linked CCPs.

The introduction of Central Counterparties (CCPs) to the OTC Derivatives market has been followed by further regulation on the issues that are critical to the safety and soundness of the CCPs. One of the issues is how to regulate and supervise the Interoperability Arrangements between CCPs.

In Europe, The European Securities and Markets Authority (ESMA) issued the Guidelines and Recommendations (‘the Guidelines’), as mandated under Article 54(4) of EMIR, ‘with a view to establishing consistent, efficient and effective assessments of interoperability arrangements’ in which EU central counterparties (CCPs) participate. As noted by ESMA, the Guidelines do not introduce new requirements for CCPs in addition to the ones specified in EMIR or the relevant technical standards. However, they specify how those requirements should be met for the purpose of establishing robust and stable interoperability arrangements.

The Guidelines and Recommendations define what National Competent Authorities (NCAs) should analyze in assessing an interoperability arrangement and therefore on what aspects of the interoperable arrangement the relevant CCPs will need to focus their attention. In the UK the NCA is the Bank of England.

In November 2014, the Bank of England published a consultation paper on the supervisory approach that the Bank was considering taking to implement the ESMA Guidelines in certain specific areas. In many of those areas, UK CCPs were already operating in line with the approaches proposed.

The Bank of England (BoE) has published the feedback it received and policy response to its November 2014 consultation. These are the five areas discussed:

(i) The level of margin that should be provided by CCP to the other (‘inter-CCP margin’): this is that CCPs' are required to assess, collect or have access to inter-CCP resources ‘necessary to cover credit and liquidity risk arising from the interoperable arrangement, including in extreme but plausible market conditions’. However, the requirement to meet exposures in ‘extreme but plausible market conditions’ poses some concerns. That requirement is achieved by the addition of other pre-funded resources, notably a mutualized default fund. Unlike an ordinary Clearing Member (CM), an interoperating CCP is not permitted to contribute to another CCP’s default fund. Thus, although interoperating CCPs contribute some additional source to the fund in 'extreme an plausible market conditions', the risk management approach would not be as rigorous as it is to the ordinary clearing members of each CCP. 


The Bank of England proposed that the CCP should collect at least the amount of inter-CCP margin from an interoperating CCP as it would ordinarily collect in margin and default fund contribution combined from a CM with the same positions. This may, however, entail additional costs for CCPs (and their members) participating in interoperability arrangements.
The respondents had different views regarding this matter: One respondent suggested that the level of inter-CCP margins should be higher than the Bank proposed. It should cover all potential losses arising from the default of the interoperable CCP in extreme but plausible market conditions. The respondent argued that this is justified because interoperability exposes CCPs to incremental risk that is substantially greater than the risk it is exposed to from a clearing member. Another respondent also disagreed with the Bank’s proposed standard, arguing that the existing inter-CCP margin collected by CCPs may already be too conservative, and in that sense inter-CCP margins could be reduced from their prevailing levels.  


The Bank decided to adopt the initially proposed standard as part of its supervisory approach towards assessing interoperability arrangements for UK CCPs. The Bank explains that taking a more conservative approach could lead to significantly higher inter-CCP margin requirements than under the Bank’s proposed approach, which would increase the cost of establishing such arrangements notwithstanding the benefits they may bring. There would be other drawbacks. For instance, the additional margin requirements would be more volatile and the mutualized default fund could be significantly smaller, as interoperating CCPs would not have uncovered stressed exposures to the CCP. The Bank did not agree that this would strike an appropriate balance between safeguarding against the systemic risk of contagion between CCPs and maintaining the benefits of interoperability.

(ii) The means by which CCPs source this inter-CCP margin: Interoperability exposes an interoperable CCP to counterparty risk from its linked CCP(s) that is new and additional to the counterparty risks arising from exposures to its CMs. These CM exposures must continue to be margined and risk-managed in accordance with EMIR. The Bank’s view is therefore that in order to satisfy this requirement, any margin posted by one CCP to another CCP should be separate from and additional to the margins already collected by a CCP to cover its exposures to CMs. This is necessary because if margin provided by a CM is posted to an interoperating CCP, it would no longer be readily available to protect against the default of the CM which has provided it. This does not preclude a CCP from calling ‘additional’ margin from CMs, which could be used as inter-CCP margin. UK CCPs are already operating on this basis, in line with the regulatory position adopted by the Netherlands Authority for the Financial Markets (AFM), De Nederlandsche Bank (DNB), the Swiss Financial Market Supervisory Authority (FINMA), the Swiss National Bank (SNB) and the UK Financial Services Authority (FSA) in 2010.

All respondents agreed with the Bank’s proposed standard on the sourcing of inter-CCP margin. Accordingly the Bank’s proposed standard will be adopted as part of its supervisory approach towards assessing interoperability arrangements for UK CCPs. 




(iii) The application of CCP default resources (other than inter-CCP margin) to exposures to interoperating CCPs: if an exposure to an interoperating CCP is amongst the two largest exposures faced by a CCP, it would set the size of its default fund and other pre-funded financial resources accordingly, and the default fund would be available to meet such a loss. This would ensure that a CCP is able to withstand the simultaneous default of its largest two counterparties, irrespective of whether they are a CM or an interoperable CCP, in extreme but plausible market conditions.
Some respondents noted that the precise design of the proposed standard could be altered. The Bank said that its aim is to implement the ESMA Guidelines, rather than to introduce new requirements. Therefore, the Bank did not propose to provide such additional guidance. The specific formulation of the CCPs’ default resources should be agreed between the CCPs and its participants, within the requirements of EMIR. In other words, the Bank is transposing ESMA Guidelines into national regulation with no further consideration to the specificities of the UK CCPs.
 Accordingly the Bank’s proposed standard will be adopted as part of its supervisory approach towards assessing interoperability arrangements for UK CCPs.
 











(iv) Arrangements to manage the impact on one CCP of the deployment of loss allocation rules by the other: UK CCPs have adopted ‘loss allocation rules’ that set out how any loss that exceeds the CCP’s pre-funded resources will be allocated to participants. Guidelines 3(a)(v)(a-b) state that interoperating CCPs should agree any changes to the rules of one CCP that will directly impact the interoperability agreement. Depending on their design, the loss allocation rules could potentially impact interoperability agreement. In the Bank’s view, interoperating CCPs should consider any interaction between their loss allocation rules and the interoperability arrangement and make changes as necessary to the interoperability agreement between them. 
 

No respondents suggested that the Bank should require CCPs to include interoperating CCPs within the scope of their loss allocation arrangements, but some noted that there could be benefits to such loss allocation arrangements agreed between CCPs on a voluntary basis. Accordingly, the Bank will not expect CCPs to include interoperable CCPs in loss allocation arrangements, but will review any voluntary arrangements agreed between CCPs and their respective regulators on a case-by-case basis. 

(v) The application of the Guidelines to interoperable arrangements for derivative products.
Regarding the last area the Bank of England accepts that interoperability for derivatives products raises similar risks as interoperability for securities products, but on a potentially greater scale, given the larger potential credit exposure on derivative products and the greater risk associated with longer-term exposures in more complex instruments. Therefore risk standards applied to interoperable arrangements for derivatives should be at least as stringent as the standards applied to interoperable arrangements for securities. 
Accordingly, the Bank proposes to apply the standards contained in the Guidelines as the minimum necessary in any interoperability arrangement for derivative products in which UK CCPs participate or propose to participate.

In other words, although the Bank recognizes the relevance that interoperability for derivatives products has, it is not providing any further guidance in this matter, not a clear interpretation on how this is different from the regime of interoperability for securities products. 


All respondents agreed with the Bank’s proposed standard on the risk standards for interoperability arrangements for derivatives products.
 Accordingly the Bank’s proposed standard will be adopted as part of its supervisory approach towards assessing interoperability arrangements for UK CCPs. 






Bank of England

Summary of feedback received and policy response July 2015

Implementation by the Bank of England of ESMA's Guidelines and Recommendations on CCP Interoperability Arrangements November 2014

The Bank of England’s approach to the supervision of financial market infrastructures. April 2013

ESMA

Guidelines and Recommendations for establishing consistent, efficient and effective assessments of interoperability arrangements. Final Report 10 June 2013