Derivatives practitioners have known for some time a regulatory backlash is coming. There have already been a few dictums, including calls to improve the infrastructure of the derivatives market, while moves are afoot to push a chunk of the credit derivatives market through clearing houses in both the US and Europe.
Now, supervisors and politicians are fleshing out proposals to regulate the derivatives market. On March 26, US Treasury secretary Timothy Geithner declared the government intended to oversee the market for over-the-counter derivatives - which would include a requirement that all standardised derivatives contracts be cleared through a central counterparty, and an obligation for non-standardised contracts to be reported to trade repositories.
One of the key failings exposed by the crisis was that regulators and dealers had no clear idea who was holding what risk. As one central banker said to Risk recently, regulators were not set up to track and untangle the global derivatives trades a single bank conducted with multiple counterparties. As a result, they had little idea what effect the collapse of one major counterparty would have - they may know, for instance, that Bank A had no direct exposure to Bank B, but did not realise Insurance Firm C was conducting huge volumes of trades with both banks, potentially causing huge problems if any one firm in the chain collapsed.
Central clearing and trade repositories should, in theory, create greater transparency and allow supervisors to identify potential systemic weaknesses. But who will have responsibility for this? The derivatives market is global and stretches well beyond the banking sector. It would make sense for some global body to take responsibility for it.
The issue has become hugely political - governments need to be seen to be doing something to regulate derivatives. As such, it is difficult to imagine national or regional supervisors abdicating responsibility for any form of oversight.
Take the US government's plan of forcing non-standardised derivatives trades to be reported to a repository. Would this include all trades, those denominated in dollars, those traded in the US or those conducted by firms with operations in the US? If all trades, how would the European Commission respond? Would it want all trades to be simultaneously reported to a repository in the eurozone, or just European trades? How closely would regulators share information? Would part of the jigsaw get lost if national supervisors just focus on trades conducted on their doorstep?
The best approach would seem to be one global repository for all trades, overseen by a single entity. But in the current environment, it is difficult to imagine individual regulators making too many concessions.
Nick Sawyer, Editor.