Tag: OTC derivatives


Focusing on Dealer Conduct in the Derivatives Market

Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s remarks at a recent open meeting of the SEC; the full text, including footnotes, is available here. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

The financial crisis of 2008 demonstrated the devastating effects of a derivatives marketplace that, left unchecked, seriously damaged the world economy and caused significant losses to investors. As a result, Title VII of the Dodd-Frank Act tasked the SEC and the CFTC to establish a regulatory framework for the over-the-counter swaps market. In particular, the SEC was tasked with regulating the security-based swap (SBS) market and the CFTC was given regulatory authority over all other swaps, such as energy and agricultural swaps.

The Commission has already proposed and/or adopted various rules governing the SBS market— such as rules that establish standards for registered clearing agencies; rules to move transactions onto regulated platforms; rules to bring transparency and fair dealing to the market for SBS; rules for the registration of dealers and major participants; rules to impose capital, margin, and segregation requirements for dealers and major participants; and rules for cross-border SBS activities.

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The Need for Greater Secondary Market Liquidity for Small Businesses

Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s public statement at a recent meeting of the SEC Advisory Committee on Small and Emerging Companies; the full text, including footnotes, is available here. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

I am delighted to see that today’s [March 4, 2015] meeting will discuss the secondary trading environment for the securities of small businesses. The lack of a fair, liquid, and transparent secondary market for these securities is a longstanding problem that needs an effective solution. Indeed, I’ve spoken publicly about this very issue on a number of occasions, most recently less than two weeks ago at the annual SEC Speaks conference. This topic is increasingly urgent in light of certain new, or anticipated, Commission rules required by the JOBS Act that would result in a far wider range of small business securities needing to find liquidity in the secondary markets. Specifically, proposed rules under Regulation A-plus and Crowdfunding, and final rules under Rule 506(c) of Regulation D, would permit wide distributions of securities and also allow such securities to be freely-traded by security holders immediately upon issuance, or after a one-year holding period. These registration exemptions also provide—or are expected to provide—for lesser on-going reporting requirements than is required for listed securities.

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New ISDA Protocol Limits Buy-Side Remedies in Financial Institution Failure

The following post comes to us from Stephen D. Adams, associate in the investment management and hedge funds practice groups at Ropes & Gray LLP, and is based on a Ropes & Gray publication by Mr. Adams, Leigh R. Fraser, Anna Lawry, and Molly Moore.

The ISDA 2014 Resolution Stay Protocol, published on November 12, 2014, by the International Swaps and Derivatives Association, Inc. (ISDA), [1] represents a significant shift in the terms of the over-the-counter derivatives market. It will require adhering parties to relinquish termination rights that have long been part of bankruptcy “safe harbors” for derivatives contracts under bankruptcy and insolvency regimes in many jurisdictions. While buy-side market participants are not required to adhere to the Protocol at this time, future regulations will likely have the effect of compelling market participants to agree to its terms. This change will impact institutional investors, hedge funds, mutual funds, sovereign wealth funds, and other buy-side market participants who enter into over-the-counter derivatives transactions with financial institutions.

Among the key features of the Protocol are the following:

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Financial Market Infrastructures

The following post comes to us from Guido A. Ferrarini, Professor of Business Law at University of Genoa, Department of Law, and Paolo Saguato at Law Department, London School of Economics.

In the paper Financial Market Infrastructures, recently made publicly available on SSRN and forthcoming as a chapter of The Oxford Handbook on Financial Regulation, edited by Eilís Ferran, Niamh Moloney, and Jennifer Payne (Oxford University Press), we study the impact of the post-crisis reforms on financial market infrastructures in the securities and derivatives markets.

The 2007-2009 financial crisis led to large-scale reforms to the regulation of securities and derivatives markets. Regulators around the world acknowledged the need for structural reforms to the financial system and to market infrastructures in particular. Due to the global dimension of the crisis and the extent to which financial markets had been revealed to be closely interconnected, national regulators moved the related policy debate to the supranational level. This approach led to the international regulatory guidelines and principles adopted by the G20 and then developed by the Financial Stability Board (FSB). The new global regulatory framework which has followed has institutionalized financial market infrastructures (FMIs) as key supports for financial stability and as cornerstones of the crisis-era regulatory reform agenda for financial markets.

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Nationalize the Clearinghouses!

The following post comes to us from Stephen J. Lubben, Harvey Washington Wiley Chair in Corporate Governance & Business Ethic at Seton Hall University School of Law.

A clearinghouse reduces counterparty risks by acting as the hub for trades amongst the largest financial institutions. For this reason, Dodd-Frank’s seventh title, the heart of the law’s regulation of OTC derivatives, requires that most derivatives trade through clearinghouses.

The concentration of trades into a very small number of clearinghouses or CCPs has obvious risks. To maintain the vitality of clearinghouses, Congress thus enacted the eighth title of Dodd-Frank, which allows for the regulation of key “financial system utilities.” In plain English, a financial system utility is either a payment system—like FedWire or CHIPS—or a clearinghouse.

But given the vital place of clearinghouses in Dodd-Frank, it is perhaps surprising that Dodd-Frank makes no provision for the failure of a clearinghouse. Indeed, it is arguable that the United States is not in compliance with its commitment to the G-20 on this point.

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The Extraterritorial Effect of the EU Regulation of OTC Derivatives

The following post comes to us from Alexandria Carr, Of Counsel with the Financial Services Regulatory & Enforcement group at Mayer Brown LLP, and is based on a Mayer Brown Legal Update; the complete publication, including footnotes, is available here.

1. On 10 April 2014 some of the legislation that provides for the extraterritorial effect of the European Markets Infrastructure Regulation (“EMIR”) came into force. The remaining legislation will come into force on 10 October 2014. This post considers this legislation and the counterparties to which it applies. It also considers whether some counterparties might be able to avoid the extraterritorial effect as a result of the European Commission making an equivalence decision in respect of third country jurisdictions. It considers the European Securities and Market Authority (“ESMA”) advice to date on the equivalence of the regulatory regimes in the US, Japan, Australia, Canada, Hong Kong, India, Singapore, South Korea and Switzerland and notes that even in the US ESMA did not find full equivalence. Finally this post also considers the requirements that third country central counterparties (“CCPs”) and trade repositories must meet in order respectively to provide clearing services to their EU clearing members and to provide reporting services to EU counterparties which enable those counterparties to satisfy their clearing reporting requirements under EMIR.

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Toward a Global Regulatory Framework for Cross-Border OTC Derivatives Activities

Michael S. Piwowar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Piwowar’s remarks at the Alternative Investment Management Association Global Policy & Regulatory Forum; the full text is available here. The views expressed in the post are those of Commissioner Piwowar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

International engagement has long been a fundamental aspect of effective capital markets regulation. As Kathy [Casey] noted in a speech she gave while Commissioner in 2007: “If we, as regulators, are to remain effective and relevant in meeting our mission of protecting investors, fostering capital formation and maintaining competitive, fair and orderly markets, we will need to be more nimble and responsive to market developments and rely more on cooperation and collaboration with our international counterparts.” [1]

It has become clear to me over these past few months that at no time in the Commission’s history have we been more engaged with the international community or more involved in collaborative workstreams with our fellow regulators from around the globe.

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The Twilight Zone: OTC Regulatory Regimes and Market Quality

Christian Leuz is the Sondheimer Professor of International Economics, Finance and Accounting at the University of Chicago.

In 2010, more than 8,000 domestic equity securities traded in the U.S. OTC market. Yet, research studying this market is limited. Stocks in this market tend to be small. The OTC market generally offers less investor protection than the traditional exchanges, and fraudulent and abusive practices in this market cause significant economic harm to investors. Thus, this market illustrates the trade-off that securities regulators face between their charter to ensure investor protection and their desire to create a viable market for small growth firms. This trade-off has come into focus with the passage of the JOBS Act in 2012, which intends to lower the regulatory burden on firms when they access public capital markets. One of its key provisions is to loosen the ownership limits for SEC registration, which will likely increase the number of unregistered securities in the OTC market. This change raises significant concerns with respect to investor protection. In light of these initiatives, it is important to understand the efficacy of existing regulatory regimes in the OTC market. In our paper, The Twilight Zone: OTC Regulatory Regimes and Market Quality, which was recently made publicly available on SSRN, my co-authors (Ulf Bruggemann, Aditya Kaul, and Ingrid Werner) and I analyze the association between these regulatory regimes and market quality.

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Navigating Key Dodd-Frank Rules Affecting Swaps End Users

The following post comes to us from Penelope Christophorou, counsel focusing on commercial financing, secured transactions and bankruptcy law at Cleary Gottlieb Steen & Hamilton LLP. The following post is based on a Cleary Gottlieb memorandum; the full text, including footnotes and appendices, is available here.

Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) enacted a new regime of substantive regulation of over-the-counter (“OTC”) derivatives under U.S. securities and commodities laws. Over the course of 2013, many key provisions of Dodd-Frank are being implemented by the Commodity Futures Trading Commission (the “CFTC”) with respect to “swaps.” While many of the regime’s requirements focus on “swap dealers” (“SDs”) and “major swap participants” (“MSPs”), commercial entities that enter into OTC derivatives transactions to hedge or mitigate risk, referred to as “end users,” will also become subject to a wide range of substantive requirements.

In particular, end users will need to:

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Regulation of Cross-Border OTC Derivatives Activities: Finding the Middle Ground

Elisse B. Walter is a Commissioner at the U.S. Securities and Exchange Commission and was the Chairman of the SEC from December 2012 to April 2013. This post is based on Commissioner Walter’s recent remarks at the American Bar Association Spring meeting, available here. The views expressed in this post are those of Commissioner Walter and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

Today at the SEC and in government agencies around the world, regulators are shaping the rules that will govern the way over-the-counter derivatives are transacted. It’s a crucial task given the magnitude and importance of this market to the international financial system.

In the process, all of us are grappling with the fact that these transactions rarely respect national boundaries. They are complex transactions that routinely cross borders, and are potentially subject to multiple sets of rules.

To ensure our regimes work effectively, we need to have a common sense, flexible approach to the cross-border regulation of derivatives.

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