During a hectic September week when international banking regulators outlined their Basel III capital requirements and the European Commission published its regulatory framework for over-the-counter derivatives, the chief U.S. futures regulator said the process of cross-border coordination is on course and suggested that systemic-risk oversight will extend to the clearinghouses, which are expected to take on more of the burden of processing swaps and other derivative products.
Speaking to the regional conference of the International Swaps and Derivatives Association in New York on September 16, Commodity Futures Trading Commission chairman Gary Gensler said his agency is actively pursuing the necessary harmonization of regulations both with the CFTC’s U.S. counterparts — including the Federal Reserve Board and the Securities and Exchange Commission — and with the EC, whose swaps-related proposals he regarded as generally compatible with those in the recently enacted Dodd-Frank Act.
Gensler went on to enumerate the organizations likely to come under CFTC scrutiny per Dodd-Frank, including an “initial estimate” of more than 200 entities that will register as swap dealers. These are likely to come from the ranks of the biggest investment banks as well as banks’ spin-offs of commodity, equity and credit default swap businesses.
Referring to the rule that standardized swaps must trade on exchanges or through designated swap execution facilities to bring greater transparency to derivatives trading, Gensler said: “Twenty to 30 new entities will register as swap execution facilities or designated contract markets. That is in addition to the 16 futures exchanges that we already regulate.”
And noting that the Dodd-Frank Act further requires central clearing of standardized derivatives, Gensler added that the number of registered derivatives clearinghouses “will increase from 14 to around 20” and that the CFTC expects to propose “a series of new rules to ensure that all clearinghouses” comply with “core principles” in the act.
“For the first time,” Gensler said in his ISDA speech, “some derivatives clearinghouses may be designated systemically important by the Financial Security Oversight Council,” the body that will be responsible for assessing and warning of large-scale systemic vulnerabilites.
The “systemically important” label will be associated with “enhanced rules for financial resources, risk management and other prudential standards,” Gensler continued. “In this regard, we are consulting very closely with the Federal Reserve and international regulators. We recognize the need for very robust risk management standards, particularly as more swaps are moved into central clearinghouses.”
Such an official designation would only confirm the status that established clearinghouses have claimed for themselves in mainstream cash securities processing, and in the solutions they have extended to derivatives clearing.
LCH.Clearnet of London, the biggest clearer of interest rate swaps, sees its OTC derivatives function as part of its overall risk-reducing, stability-enhancing mission. Its CEO, Roger Liddell, said after the signing of the Dodd-Frank Act in July that “the new law takes major steps in preventing another financial crisis from occurring. . . . We stand ready to meet all requirements under the new law and look forward to expanding our presence in the U.S. market.”
The New York–based Depository Trust and Clearing Corp., which has considerably enhanced transparency and contributed to risk reduction by registering virtually all global credit derivatives trades in its Warehouse Trust subsidiary, views itself not only as a systemically important service provider, but also as a crucial window on the financial infrastructure and on measures to reform and reregulate it.
In a speech in May to a Securities Industry and Financial Markets Association conference, DTCC chairman and chief executive Donald Donahue noted that his organization last year hired a chief systemic risk officer, Anne (Nan) Noonan, formerly executive vice president and head of risk management at the foreign exchange settlements institution CLS Bank International. Despite DTCC’s successful management of the Lehman Brothers crisis — in which LCH.Clearnet also played a heroic role — and its “track record of mitigating risk for our members,” said Donahue, “we also recognized that we still had work to do.”
He added, “My instinct is that now more than ever, DTCC can play an even greater role in further mitigating risk and enhancing transparency for the industry. . . . So we’ve been hard at work on Capitol Hill and in Europe, giving voice to critical issues facing the industry and working to shape outcomes that serve the interests of the industry, regulators and the public.”
In that sense, the clearinghouse makes common cause with the ISDA, whose CEO, Conrad Voldstad, said at a media briefing during the regional meeting, “We are all for clearinghouses” and are “committed to making them strong.” In prepared remarks earlier, Voldstad had said, “We must be sure prudent, effective risk management of clearinghouses is in place, especially where clearing does not result in the destruction of contracts as occurs in CDS clearinghouses. This means a continued focus on [the risk-reducing processes of] tear-ups and portfolio compression.”
Expressing broad support for the European Commission’s OTC derivatives regulations, Frankfurt-based Deutsche Börse Group pointed to “the strong prudential requirements for central counterparties that should foster harmonization across Europe and ensure that CCPs continue to perform their risk management and risk mitigation roles.”
Jeffrey Kutler is editor-in-chief of Risk Professional magazine, published by the Global Association of Risk Professionals.