(The article featured below is a selection from International Securities and Financial Reporting Update, which is available to subscribers of that publication.)

Derivatives Industry Accepts EU Regulation in Principle

While expressing general support for European Commission derivatives regulation initiatives, the derivatives industry cautioned against forcing customized derivatives on to exchanges. ISDA, SIFMA and the London Investment Banking Ass’n. also said that close global cooperation is essential to ensure a harmonious approach among different regulatory regimes and to foster appropriate standards for infrastructure solutions. This is similar to the message the industry delivered in testimony to Congress on the Obama Administration’s proposed legislation on derivatives.

The industry believes that the regulatory focus should be on process uniformity, not product uniformity. Exchange trading is not required to achieve this, they believe, and it would not insulate the financial system from risk or reduce losses in a challenging environment. The associations are pleased that the Commission recognizes that different asset classes, ranging from credit derivatives to equities and interest rate swaps, are unique and require customized procedures and infrastructure.

The associations also pointed out that Central Counterparty ("CCP") clearers need to work closely with clearing members to carefully determine the eligibility of individual contracts for central clearing based on the key characteristics of the product class in question, the capability of the CCP, and the ability of major market participants to support the default process. The process should ensure that no new products are added without appropriate risk-management testing.

Moreover, CCPs need to demonstrate an exceptional level of financial and operational robustness and great care must be taken to develop fundamentally sound platforms and services. Regulators should continue to insist on high quality standards and stability for any CCP so the market can be certain that it is a strong and capable counterparty. The associations support the recommendations made by CESR and call for adherence to them in order to establish a legal framework for CCPs.

ISDA, SIFMA and LIBA are not in favor of additional new penalties for contracts that are not centrally cleared. They feel that existing capital charges are already a significant incentive for market participants to use a central clearing house. Additionally, while there are benefits from having CCPs in privately negotiated derivative markets, the associations believe there are also strong reasons for not clearing all trades.

The associations believe that central data repositories are in principle relevant for systemic participants in all asset classes, though it is also critical that their usage does not curtail the flow of new products to the market. Access to data repositories should be granted to all relevant major financial regulatory bodies.

The associations support the collateralization of interdealer OTC trades, with a focus on the quality of posted collateral and the speed with which it can be liquidated in a default scenario. They also noted that, although considerable progress has been made over the last few years to harmonize the close-out netting and collateral regimes across Europe, significant areas of legal uncertainty remain. Thus, further legislation to address these uncertainties would be beneficial, specifically harmonizing close-out netting and collateral arrangements across the EU.