International Reform of OTC Derivative Regulation: How Level Is the Playing Field? (July 2011)

International Reform of OTC Derivative Regulation: How Level Is the Playing Field? (July 2011)

 

By Morrison & Foerster LLP

Excerpt: 2011 Emerging Issues 5904


SUMMARY: Increased regulation of derivatives has been a key element of international efforts to strengthen the global financial regulatory framework. There is great concern that the interconnectedness of large financial institutions, and fears that the failure of a firm with large derivative positions had the potential to cause significant systemic problems to the global financial markets.

Background

Increased regulation of derivatives has been a key element of international efforts to strengthen the global financial regulatory framework. Following the bailout of AIG, primarily due to its massive exposure under credit default swaps, the initial focus of regulators was in relation to increased regulation of credit default swaps, including greater standardization of contract terms and more central clearing of standardized CDS contracts. Although there is little evidence that over-the-counter derivatives ("OTC derivatives") were a material factor in the causes of the financial crisis, the focus moved quickly to OTC derivatives more generally, following the failure of Lehman Brothers with concerns over the interconnectedness of large financial institutions, and fears that the failure of a firm with large derivative positions had the potential to cause significant systemic problems to the global financial markets. In addition, concerns were raised that a lack of transparency meant that regulators and market participants did not have the information necessary to assess the full extent of parties' exposures to each other.

In response to the crisis, the G-20 leaders made the following commitment in Pittsburgh in September 2009:

"All standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest. OTC derivative contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements. We ask the FSB and its relevant members to assess regularly implementation and whether it is sufficient to improve transparency in the derivatives markets, mitigate systemic risk, and protect against market abuse."...

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