International OTC derivatives reforms

1. International OTC derivatives reforms Chris Bates, Partner, Clifford Chance, London • September 2012

2. Forces shaping regulation of OTC derivatives • Regulation is being shaped by several powerful forces • The financial crisis • The euro crisis • The G20 agenda • Global rebalancing • Competition policy • Politics • Differing views from global regulatory bodies The effects are beginning to profoundly alter the shape of the OTC derivatives market There is a lot of legislation and still a long way to go......

3. The international agenda • *G20 agenda item International OTC derivatives reforms

4. Marketreforms – G20 commitments • “All standardized 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.” • G20 Pittsburgh, September 2009 4

5. Simple instructions, complex outcomes • Obligation for counterparties to clear eligible OTC derivatives with registered central counterparties (CCPs) • Obligation to execute eligible transactions through a trading system, not bilaterally • Obligation to report all transactions to a registered trade repository • Obligation to collect/post initial or variation margin on uncleared transactions • Regulation of confirmation process, portfolio reconciliation, trade compression and client documentation • Pre- and post-trade transparency for OTC transactions • Position limits/position management powers for commodity derivatives • Licensing or registration requirements for dealers and systemically important end-users • Business conduct rules for market participants, extension of market abuse rules • Regulation of CCPs and trade repositories International OTC derivatives reforms

6. Points of difference • Different pace of reform around the world • US, EU, Asia • Clearing, reporting, margining vs. trading, transparency • Scope issues • Instruments: e.g. FX, physical commodities and securities • Entities: e.g. treatment of end-users, intra-affiliate trades, pension funds, central banks • Margining of uncleared trades • Initial margin and collateral thresholds • Extraterritoriality and overlapping, conflicting rules • Different approaches to territorial nexus e.g. location of counterparties, arranger, transaction underlying • Extra-territorial application of licensing rules • Regulation of CCPs and trade repositories

7. Basel III • Basel III supplemented by national initiatives to raise bank capital • EU and US stress tests • Additional capital buffers e.g. UK, Sweden, Austria, Switzerland • More, better quality capital and enhanced deductions from capital • Focus on equity and additional buffers, including G-SIB buffers • Plus unweighted leverage ratio • Increased risk weights for assets affect OTC derivatives • CVA: credit valuation adjustment • Additional capital charge for exposures to large financial institutions • Capital charges for client business cleared with a CCP • Trading book review • Liquidity risk regulated through liquidity coverage ratio and net stable funding ratio International OTC derivatives reforms

8. Bank structural initiatives • *G20 agenda item International OTC derivatives reforms

9. Recovery and resolution • International convergence of resolution regimes • Financial Stability Board publishes key attributes • Requirement for recovery and resolution planning • Possible resulting structural changes to banks to facilitate resolution • Recognition that ordinary insolvency regimes inadequate for systemically important institutions • US FDIC/orderly liquidation regime, UK Banking Act, German regime, EU proposed directive • Debate over the role of “bail-in” as a resolution tool • Write down of junior and senior liabilities or conversion into equity • Impact on derivatives International OTC derivatives reforms

10. Market outcomes • Restriction on banks’ derivatives capacity • Client and bank response may result in regional booking silos • Reduction in product range • Increased barriers to entry for smaller market participants • Increasing importance of CCPs • Focus on financial stability issues and market structure • Possible new market entrants: “shadow banks” • Winners and losers International OTC derivatives reforms