Tuesday, October 21, 2014

CFTC Global Roundtable Examines Clearing for Non-Deliverable Forwards

As the CFTC readies a proposal on the clearing of non-deliverable forwards, the Commission convened a global meeting to discuss whether mandatory clearing should be required of NDF swaps contracts. The meeting was under the auspices of the CFTC’s Global Markets Advisory Committee, chaired by Commissioner Mark Wetjen. At the start of the meeting, Commissioner Wetjen announced the formation of a subcommittee on foreign exchange (FX) experts.

Brian O’Keefe, CFTC Deputy Director, Division of Clearing and Risk, noted that, with regard to the NDF clearing mandate, there is no specific recommendation currently on the table , but that there has been some staff work done on this.

Without going into all of the details of the recommendation because it is subject to change, he said that one of the first questions to be addressed about the mandate is which currency pairs should the CFTC be focusing on. There are a number of trading activities and a variety of different pairs, but the liquidity characteristics are different depending on the pair.

The staff is also thinking about creating a clearing requirement. In his view, there are a number of factors that need to be considered in determining mandatory clearing, including outstanding notional amounts, trading liquidity, adequate pricing data, framework capacity and operational expertise to clear these products, and the effect of mitigation of systemic risks on competition.

Essentially, the proposed class would have 12 reference currencies and those 12 represent the ones that have been submitted to the CFTC. The settlement currency would be U.S. dollars. The staff is doing its analysis with regard to liquidity around that.

He noted that the staff conducted an initial analysis using the real time reporting data at the end of 2013 and into the spring of 2014 that showed that there was approximately $7.4 trillion in the NDF currencies. What is striking, he said, and needs to be addressed, is that most of this is in uncleared transactions. This goes to the factor of capacity and the ability that clearinghouses have to take on that additional volume.

Rodrigo Buenaventura, Head of Markets Division at the European Securities and Markets Authority (ESMA), noted that ESMA has six months to decide whether to propose clearing for this type of derivative. ESMA has already sent a proposal to the European Commission on interest rate derivatives, he said, and a proposal on credit default swaps is expected by the end of November. That leaves the third instrument, NDFs. ESMA will concentrate on whether that particular class should or should not be subject to compulsory items.

Under the E.U. process, after ESMA submits a proposal and the European Commission approves it, the E.U. Parliament or Council could intervene upon a belief that the standard is contrary to Level 1 legislation, in this case ,the EMIR Regulation. While this has not yet happened in the last three years, he noted, it remains a possibility that must be respected.

In terms of the criteria of the product, ESMA must assess three elements: standardization, reliability of pricing and liquidity. Regarding standardization, ESMA found that the level of standardization of is very high and comparable to credit and interest rates swaps.

But there are some peculiarities with NDFs, he cautioned, one of which is maturity, with the maturity of most trades being below three months, which he described as being very short. Indeed, 90% of maturities are below three months, 30% are below 30 days, and 10% are less than seven days.

David Bailey, Director of Financial Market Infrastructure for the Bank of England, spoke from the perspective of a supervisor of the clearinghouses. From that oversight aspect, he noted, when considering a clearing mandate the focus is the capacity of the central counterparty. While that is something regulators have usually considered when authorizing a central counterparty to clear a product, he observed, it is very important that regulators refresh their analysis when a clearing mandate is considered. Other factors that must be considered are size and scale, and liquidity.