Preparing for Failure
The Financial Stability Board is making progress toward its goal of establishing global standards for resolving clearinghouses that have passed the point of recovery. On Feb. 1, the international body, which consists of representatives from central banks and finance ministries of the G20 nations, published a consultation paper on draft guidance for resolution planning for central counterparties.
The consultation paper builds on a "discussion note" issued in August 2016 that outlined the group's views on the essential aspects of CCP resolution planning. The focus on resolution planning is a core element of a broader effort launched by international regulators in 2015 to strengthen regulatory, oversight and supervisory requirements for derivatives clearinghouses in recognition of their greater importance to the stability of the global financial system.
"With CCPs an increasingly important part of the financial system, particularly following post-crisis reforms to mandate central clearing of certain standardized over-the-counter derivatives, it is vital that CCPs do not themselves become a new source of too-big-to-fail risk,” the FSB said.
The draft guidance covers a range of issues that authorities should consider when developing frameworks for resolving failing CCPs. These include:
■ Policy objectives for CCP resolution planning to maintain financial stability
■ Powers that resolution authorities should have to ensure the effective resolution of CCPs, including potential indicators for considering when a CCP should enter resolution
■ Use of loss allocation tools in resolution and provisions necessary to protect creditor rights so the triggering of resolution by authorities does not leave creditors worse off than if the authorities had not stepped in
■ steps authorities should take for CCP resolution planning, including assessing resolvability and considerations about the formation of crisis management groups for systemically important CCPs
The FSB said it expects to finalize the guidance in June 2017 in advance of the G20 summit that will take place in Germany. The FSB added that it plans to undertake further work on the topic of "financial resources for CCP resolution" and determine by the end of 2018 whether it should develop further guidance on this issue.
FIA has consistently supported the efforts by international regulators to enhance CCP resiliency, recovery and resolution. In October, FIA joined with four other financial trade associations in responding to the August discussion note on CCP resolution. The associations welcomed the note as "an important step toward addressing the financial disruption that could occur in the unlikely event that a CCP fails" and outlined seven principles that regulators should consider in developing CCP resolution regimes and strategies.
On Feb. 3, President Trump issued an executive order outlining seven core principles for financial market oversight and calling on regulators to review existing laws and regulations to determine if they promote these principles.
The core principles include fostering economic growth and "vibrant financial markets" through more rigorous analysis of regulatory impact. The principles also include making regulation "efficient, effective and appropriately tailored," preventing "taxpayer-funded bailouts," and advancing the interests of the U.S. in international financial regulatory negotiations and meetings.
White House officials explained that the order will be the first step toward fulfilling Trump's campaign promise to dismantle the Dodd-Frank Act and replace it with new policies to encourage economic growth and job creation. The order does not, however, explicitly call for the repeal of the 2010 law. Instead, it directs the Treasury secretary to conduct a review over the following 120 days and report back to the White House on the extent to which existing "laws, treaties, regulations, guidance, reporting and recordkeeping requirements" promote the seven core principles.
The review process will be directed by Steven Mnuchin, who was sworn in as Treasury Secretary in February. As part of that process, Treasury will consult with the member agencies of the Financial Stability Oversight Council, which includes the Commodity Futures Trading Commission, the Securities and Exchange Commission and the Federal Reserve.
On Feb. 3, FIA issued a statement welcoming the decision to review the regulatory framework and reiterating the concerns that the association outlined in an open letter to U.S. policymakers on Jan. 25. In that letter, FIA urged the Trump administration and Congressional leaders to rely on three broad principles as they reassess the regulations put in place on the derivatives markets since the financial crisis. Those principles are smart regulation and enforcement, globally accessible markets, and innovation and competition.
"Now is the appropriate time to review and simplify the regulatory framework developed following the financial crisis and determine whether these regulations are in fact meeting their public objectives," FIA's President and CEO Walt Lukken wrote in the letter.
On Jan. 12, the U.S. House of Representatives passed the Commodity End-User Relief Act, a bill that would authorize the CFTC to operate through 2021. The bill, which was approved by a vote of 239 to 182, will need to be considered in the Senate before it can be enacted into law.
The bill includes several provisions exempting end- users from a range of Dodd-Frank requirements. The bill would exclude from the definition of swaps any forward contract resulting in the physical delivery of commodities as well as contracts with volumetric optionality. On position limits, the bill would require the CFTC to recognize bona fide hedging transactions as part of the exemption from limits. Lawmakers approved an amendment offered by House Agriculture Committee Chairman Mike Conaway (R-Texas) that restores the CFTC's authority for setting position limits as it existed before enactment of Dodd-Frank, with the exception that it would continue to be available for swaps.
A provision in the bill would prohibit the CFTC from requiring firms to turn over proprietary source code or similar intellectual property without a subpoena, effectively undoing a provision in the CFTC's proposed Reg AT that would allow the CFTC to request this information via a special call.
Lawmakers also approved an amendment that would exempt swap transactions between affiliated companies from certain Dodd-Frank requirements. The bill would set the de minimis threshold permanently at $8 billion for determining when swap dealers and major swap participants fall under a range of CFTC regulations. The CFTC would have to take an official regulatory action to change this threshold rather than automatically lowering the threshold, as set out under current regulations.
There are also several provisions in the bill that cover procedural issues at the CFTC. For example, the bill would require a public comment and notice period for commission statements or guidance that is voted on and issued by the CFTC. The bill also would require the CFTC to develop internal procedures for staff issuing exemptive, no-action or interpretive letters to the public.
On Jan. 26, the CFTC's division of swap dealer and intermediary oversight issued a no-action letter enabling futures commission merchants to withdraw excess residual interest in cleared swaps customer accounts under certain conditions. The division said it determined that the relief, which was requested by FIA on behalf of its clearing firm members, is warranted for withdrawals that "directly correspond" to customer margin payments received prior to the completion of the daily cleared swaps segregation calculation. The division explained that this will address a "timing gap" between the flow of margin payments collected from customers and the calculation of the amount of capital that FCMs have to deposit into their cleared swap customer accounts to cover any shortfall in customer margin.
On Feb. 17 FIA submitted a letter to the Federal Reserve Board requesting more careful study before the regulator moves forward on proposed requirements that would restrict bank activities in physical commodities. FIA said that it continues to have significant concerns regarding any potential new restrictions on financial holding companies' physical commodities activities, including the physical settlement of commodity-linked swaps and other derivatives. FIA repeated that restrictions on those activities would likely impair competition and liquidity in physical commodities markets, undermine the critical intermediary, principal and financing role of banks in such markets. "We submit that any potential benefits of such restrictions do not outweigh these harmful market effects," FIA wrote.
Countdown to April
Canada is set to implement mandatory clearing for interest rate swaps and certain other OTC derivatives in April, following the finalization of two sets of rules on Jan. 19 that spell out what instruments and which entities are subject to the new requirements and strengthen the protections around customer positions and assets.
“These national instruments are designed to align with international standards and provide safeguards in the Canadian market for counterparties transacting in OTC derivatives, while fostering a flexible and competitive market for clearing service providers,” said Louis Morisset, president and CEO of the Autorité des marchés financiers in Quebec and chairman of the Canadian Securities Administrators, the umbrella organization of the market regulators in each province.
The National Instrument 94-101, known as Mandatory Central Counterparty Clearing of Derivatives, requires certain counterparties to clear certain standardized OTC derivatives through a central counterparty, subject to exemptions set out in the instrument. This rule is set to take effect on April 4 and will apply to clearinghouse members and any of their affiliates with more than $1 billion in outstanding OTC derivatives. The rule also will apply to local counterparties with more than $500 billion in outstanding OTC derivatives. The derivatives covered by the clearing mandate consist of various types of interest rate swaps and forward rate agreements denominated in U.S. dollars, euros, British pounds and Canadian dollars.
The National Instrument 94-102, known as Customer Clearing and Protection of Customer Collateral and Positions, is designed to protect a local customer’s positions and collateral when clearing OTC derivatives and to improve clearing agencies’ resilience to default by a clearing intermediary. The rule includes requirements related to the segregation and portability of customer collateral and positions as well as detailed record-keeping, reporting and disclosure requirements. This rule takes effect on July 3, upon approval.
The CSA noted that in response to comments received during the consultation process, both national instruments provide certain exemptions for foreign entities that comply with similar laws of the U.S. or the European Union.