In the paper I recently published on the OTC Derivatives Market I said that the US Treasury Secretary Geithner had a strong desire to regulate the entire OTC market. On 14 May the US Treasury published its proposals. These are a mixed bag of good and bad news for OTC market participants.
The main proposal – that there should be much greater transparency of firms’ exposure to these markets – must be a good step. It would seem that this transparency is going to be achieved through a requirement that all standardised OTC derivatives should be cleared through a regulated central counterparty (CCP). The OTC community has already agreed with the EU Commission that it will take similar steps in Europe. OTC dealers will also be subject to a “robust regime” of prudential supervision and regulation including conservative capital requirements. This latter step will not be welcomed by the IDBs, but it is difficult to argue against, given the way in which the financial crisis developed.
What is rather more debatable is the intention to amend legislation in the US which would authorise the CFTC and the SEC to impose the movement of standardised OTC trades onto regulated exchanges and regulated electronic trade execution systems (what we might call MTFs in Europe). Clearly the SEC and/or CFTC might or might not exercise such powers, but I still fail to see why this provision needed to be included. The OTC Derivatives market has always been an incubator for public exchanges, but it has also been a commercial decision to determine the appropriate time for a particular product to have reached a stage of maturity and standarisation where it is ready to move onto an exchange. I fail to see why this decision should now be in the hands of a regulator.
There is a further concern I have about the proposals. Nowhere in the Treasury paper is there a reference to which particular derivatives the proposals are meant to apply. There is a reference to “all standardised OTC derivatives” – surely this cannot mean interest rate derivatives or FX transactions, none of which were implicated in the crisis? But when one looks at Mary Shapiro’s statement welcoming these proposals, she refers to the central clearing of “credit default swaps and other OTC derivatives”. As I pointed out in my paper there is very little objective evidence that CDS were significantly involved in the causes of the crisis. Collateralised Debt Obligations on asset-backed securities were the main guilty parties and there is at least one view, expressed at a recent meeting of the ISDA that I addressed, that CDOs are more akin to securities than derivatives.
The issue that must be of concern to the OTC community is the extent to which these new rules about to be imposed in the US (for there seems little doubt that they will be imposed) will leach into the European market place. Most of this market (43%) is transacted out of the UK. Is it possible that the 24% that is done in the US may now shift to the UK? Or will the UK and EU regulators seek to emulate the US regulators in imposing draconian rules on this market?