By Lene Powell, J.D.
To reduce cross-border regulatory conflict and duplication, the International Swaps and Derivatives Association, Inc. (ISDA) published a framework to allow for substituted compliance based on risk-based principles. Separately, ISDA also published recommendations for a comprehensive recovery and resolution framework for central counterparties (CCPs).
Risk-based comparability. ISDA’s new paper, “Cross-border Harmonization of Derivatives Regulatory Regimes: A Risk-based Framework for Substituted Compliance via Cross-border Principles,” proposes risk-based principles for making comparability determinations and analyzes the derivatives regulatory frameworks of certain G-20 countries against those principles. The goal is to smooth the process for assessing regulatory comparability, reducing the risk of failure and resulting market fragmentation.
“By assessing only those rules that are meant to tackle risk, and determining whether they achieve comparable outcomes with the rules of another jurisdiction, it avoids an unnecessary, granular rule-by-rule analysis that takes a lot of time and can ultimately result in failure,” explained ISDA chief Scott O’Malia.
ISDA suggests that the CFTC’s cross-border jurisdiction is too broad and its substituted compliance approach overly burdensome. The paper offers five principles covering capital and margin requirements, risk management, recordkeeping, swap data reporting, and clearing and settlement. Together with associated policy goals, the principles form a framework focused on reducing risk.
Noting that comparability simply means that regulations achieve the same overarching goals, the paper also analyzes the CFTC legal framework and compares the regulatory frameworks of several G-20 jurisdictions (the EU, Australia, Canada, Hong Kong and Japan) and Singapore against the cross-border principles, illustrating similarities and highlighting regulatory gaps. The paper also includes a section on derivatives regulations in G-20 emerging markets, using Brazil and Mexico as examples.
CCP recovery and resolution. According to ISDA, the volume of cleared derivatives has increased significantly over recent years, with the Bank of International Settlements reporting a clearing rate of 76 percent of interest rate derivatives notional outstanding. Although the largest global banks and their clearing member units have increased capital by an estimated $1.5 trillion since the financial crisis, comprehensive resilience, recovery and resolution strategies are still critically important.
Recovery refers to measures a central counterparty can take to ensure continued viability upon extreme distress. Resolution refers to measures a resolution authority would take in accordance with a statutory resolution regime to resolve a CCP if a recovery is not successful. Building on work by the Committee on Payments and Market Infrastructures (CPMI), the International Organization of Securities Commissions (IOSCO) and the Financial Stability Board (FSB), ISDA published a paper entitled “Safeguarding Clearing: The Need for a Comprehensive CCP Recovery and Resolution Framework”.
In the paper, ISDA makes 10 recommendations to increase CCP resilience and implement robust, unambiguous and predictable recovery and resolution mechanisms. The recommendations address haircutting, position allocation, and tear-ups, among other subjects. In addition to the recommendations, ISDA provides detailed questions to be considered in creating a regime that will provide maximum transparency and predictability, determine when the process should proceed from recovery to resolution, allocate default and non-default losses, rebalance a CCP’s book, and ensure adequate liquidity.
“These recommendations should serve to strengthen CCP oversight, and serve as a global and trusted foundation on which regulators can reliably base equivalence decisions,” said O’Malia.