The effects of new regulation from the US and Europe are drawing closer, whilst rule making is still not complete, and unpredictable, the regulators deadlines are becoming more clear.

UPDATE Nov 2nd: This post has been superseded by this one: https://theotcspace.com/2012/05/30/emir-compliance-dates-moved/

For dutch viewers: Emir Status En Tijdlijnen

Background

Since the collapse of Lehman Brothers in 2010, politicians have wanted to bring the OTC derivatives markets under greater control. Their approach to this in the US Congress was to pass a long and complex reform law now referred to as the Dodd Frank Act, named after Chris Dodd and Barney Frank, the two senators who sponsored the bill. Having approved the Dodd Frank Act, the two major regulators, the Securities and Exchanges Commission (SEC) and the Commodities and Futures Trading Commission (CFTC) have been busy turning what was a 2300 page law, into practical rules to be implemented by banks and financial institutions. Likewise in Europe the completion of the political process has just occurred and a final text of the European Markets Infrastructure Regulation (EMIR) will be published soon. Like the US, this must then be translated into practical rules by the European Securities and Markets Authority (ESMA). A large part of their reforms (in the US and EU) results in three major areas of change:

1. Trading of OTC products on fully electronic platforms
2. Central clearing of OTC products
3. Reporting of OTC trades into new Repositories

Each of these areas of change will result in dramatic changes in the way OTC products are processed, and not least the direct and indirect costs of those products, through service fees or increased margin requirements.

Update

In the US, the CFTC and SEC have set the end of June as their target to complete rule making to implement the Dodd Frank Act. The CFTC published a simple timetable for rule making split into two parts (see https://theotcspace.com/2012/01/30/cftc-rule-writing-schedule-time-line/) and the SEC has a “timeline” on their website. Most people are sceptical that the deadlines will be achieved, as there are considerable requirements on the CFTC and SEC to invite comments on their draft rules, plus they are supposed to complete a “cost benefit analysis” for each new rule. Already ISDA and SIFMA have begun court proceedings to block the imposition of position limits in commodities markets, due to a perceived but unproven attempt by participants to manipulate the market through building large long positions. Meanwhile in Europe, the troika of the European Parliament, Commission and Council have finally agreed a text of EMIR, which can then be handed to ESMA for implementation. The final EMIR text has yet to be published, and ESMA believe they need at least six months to complete their work. Rule making is likely to be complete by mid-year or end of September in Europe – firms can take up electronic trading and new clearing solutions right now, but have limited time to comply with the new regulations. In the US, there are compliance periods allowing time to complete implementation of the rules, for the largest firms only 90 days, for the smallest 9 months (270 days). Taking this into account, most dealers or investment managers will need to have implemented the CFTC and SEC rules by the end of September this year, that means using SEFs for electronic trading, CCPs for clearing, and sending trades to Repositories for reporting amongst many things. In Europe, the obligation to comply with the as-yet unwritten rules from ESMA is intended to be from January 1st 2013, it’s too soon to predict whether this will be true, there may be slippage yet. If you’re a European firm trading with a US dealer, or branch of a US dealer, then you will automatically be captured by the obligation to use clearing, and under the current rules, at a US CCP. The mirror of that situation occurs in Europe where the rules oblige a non-European firm trading into Europe to abide by the ESMA rules, and use a European CCP. The overlapping and incompatible rules are referred to as the extra-territoriality issue – something that needs to be resolved to avoid a clash.

Trade reporting

One of the key technology deliverables will be the delivery of data to the new Trade Repositories. The regulations may required the data to arrive within a window of between 15 minutes to an hour, so requiring firms to create an efficient capture process, with connections into the relevant Repository. Below shows the current plans for repositories, at the moment it is unclear how many are vying for attention in each asset class. To confuse matters, DTCC is having to create two destinations, one for US only data, the other for global data, due to a legal constraint with the CFTC. In addition the London Stock Exchange also suggested they may enter this space, along with possible expansion from the Spanish REGIS-TR service which is already live. From a technology perspective DTCC is already linked to many firms for the Trade Information Warehouse using IBM MQ and FpML to interact with bank systems. For other firms, it would be prudent to establish the technology stack required to enable connection, and discuss with your business sponsors the approach your firm wants to take. And finally, MarkitSERV has already built the capability to report trades direct to DTCC on your behalf, so that may solve your problem, assuming all your OTC business is processed by their confirmation service.

Extra territoriality

Any firm who knows they will be affected by the US or European rules, needs to begin planning now to adapt their systems, procedures and workflows to this new reality, not the least of which is the big increase in margin costs via clearing, and soon for un-cleared business, which may cause a re-think on the profitability of many OTC products. Given the demand on resources in banks and investment managers, spending time analysing the impacts now, will avoid a mad rush in the summer, the worst time to need extra staff.