The International Organization of Securities Commissions (IOSCO) has recommended high-level international standards for the regulation of market participants that are in the business of dealing, making a market or intermediating transactions in OTC derivatives. Historically these derivatives market intermediaries have not been subject to the same level of regulation as participants in the traditional securities market. Without sufficient regulation, said IOSCO, some derivatives intermediaries operated in a manner that created risks to the global economy that manifested during the financial crisis of 2008. Noting that many derivatives intermediaries operate in multiple jurisdictions, IOSCO emphasized that consistency among market authorities with respect to the regulation of derivatives intermediaries is essential to the successful oversight of the global OTC derivatives market.
The IOSCO recommendations follow on the commitment by G-20 leaders to reform the OTC derivatives market in response to the crisis. They take into account distinctions between the OTC derivatives market and the traditional securities markets, and the differences in jurisdictional approaches of international market authorities. The recommendations are intended to address the obligations of derivatives intermediaries that should help mitigate systemic risks and the requirements intended to manage counterparty risk in the OTC derivatives markets, as well as to protect participants in the OTC derivatives markets from unfair, improper or fraudulent practices.
As a threshold matter, IOSCO recommends that derivatives market intermediaries subject to registration and regulation should generally include those who are in the business of dealing, making a market or intermediating transactions in OTC derivatives. Thus, derivatives intermediaries should not include end-users and market participants who enter into OTC derivatives transactions but are not engaged in the business of dealing, making a market or intermediating transactions.
More specifically, IOSCO recommends that derivatives intermediaries be subject to capital requirements and business conduct standards, including prohibitions against fraud, manipulation and other abusive practices. Business conduct requirements should be tailored for the OTC derivatives market and based on the reasonable assessment of the nature of the party dealing with a derivatives intermediary or on the complexity of, and the risk associated, with the specific OTC derivatives product.
Importantly, IOSCO recommends that derivatives intermediaries be required to have effective corporate governance frameworks designed to ensure appropriate management of OTC derivatives activities, including risk management systems to identify and manage their OTC derivatives-related business risks. They should also be required to establish systems of control sufficient to provide reasonable assurance of compliance with regulations. They should also develop an effective business continuity plan, based on their size and risks, to allow them to mitigate and respond to business disruptions.
With regard to cross-border issues, if a derivatives intermediary registered in its home jurisdiction is carrying on OTC derivatives business in another jurisdiction in which it is not registered, IOSCO recommends that the market authority of the host jurisdiction in which the derivatives intermediary is carrying on business should ensure that there is appropriate supervisory arrangements in place for that OTC derivatives business, including how the derivatives intermediary is supervised in the host jurisdiction and any cooperative arrangements in place between the market authorities of the home and host jurisdictions. Market authorities are urged to closely cooperate to identify overlaps, conflicts and gaps between jurisdictions with respect to cross-border issues relating to the regulation of derivatives intermediaries and ensure that the activities in the host jurisdiction are adequately supervised. It is further recommended that jurisdictions coordinate their approaches via multilateral or bilateral channels to reduce overlaps and conflicts.