The G20 mandated the Financial Stability Board in June 2010 to craft global principles for national and international rules aimed at reducing risk in over-the-counter derivatives markets. The FSB’s progress over the past year suggests the G20 still needs to exert political pressure on member governments to follow through on its goal to make clearing of OTC derivatives mandatory by the end of 2012. It’s unlikely regulators will reach the goal unless the G20 establishes a dialogue among its members to negotiate a universal framework for the clearing of OTC derivatives, and puts the implementation of this framework at the top of its agenda for 2012.
To reduce risk in the OTC markets the FSB made four recommendations: First, standardization of financial instruments and operations to encourage more frequent clearing. Specifically, the FSB urged standardization of legal contractual terms and technical operational processes. It is impossible to standardize all OTC derivatives because investors need bespoke contracts. The challenge for market regulators is to distinguish between contracts created to hedge and those created to circumvent standardization.
Second, to clear the standardized contracts, market participants must have direct or indirect access to central counter parties. CCPs help to “mutualize” risks. The FSB said international and national authorities should ensure that the non-cleared products don’t increase bilateral risk and that CCPs do not become sources of systemic risk in themselves.
Third, the FSB wants to promote OTC derivatives markets transparency. Therefore, the FSB suggests trading on exchange or electronic trading platforms to reduce opacity. More precisely, transactions prices and volumes will be commonly disclosed.
Finally, the FSB recommends the creation of trade repositories to compile and consolidate data for global comparison and analysis.
Many developed countries, including the U.S., Japan, the E.U. and Hong Kong, are implementing reforms related to FSB recommendations regarding OTC derivatives. More precisely, the OTC derivatives clearing is contained in the Dodd-Frank Act in the U.S. The European market infrastructure regulation, or Emir, and the Markets in Financial Instruments Directive, MiFID II are in charge of implementing OTC derivatives reforms. None of these mechanisms has yet been finalized. Hong Kong is committed to OTC derivatives reforms, but it is not clear if they will be able to comply with the 2012 deadline. In other markets, such as Canada and Korea, there has been considerable policy analysis; however, regulatory amendments have yet to be taken. Australia, India, Mexico, Saudi Arabia, South Africa and Switzerland decided to assess their OTC markets and implement changes throughout 2011. Finally, China and Russia agreed to the implementation of the FSB’s OTC commitments but no clear timetable is presented. The FSB admits that “While recognizing the implementation challenges and the complexity of the needed laws and regulations ... jurisdictions should aggressively push forward to meet the deadline in as many reform areas as possible.”
The global implementation of OTC derivatives markets’ regulation was an important challenge facing G20 leaders during Cannes summit. However, the bailout of Greece and the Italian economic turmoil dominated all discussions. The FSB insists that the successful implementation of OTC derivatives’ regulation will diminish the likelihood of future financial crises. Therefore, securing the political commitment of all countries to put into practice the reforms of OTC derivatives’ regulation, as soon as possible, remains a key challenge facing G20 leaders.