Scott O'Malia: time for a regulatory time out

Isda chief calls for a pause in rule-making to "fix the errors", as the association heads into its thirtieth annual general meeting

Scott O'Malia, International Swaps and Derivatives Association

A time out, a stock-take, a chance to fix some problems – that is what Scott O'Malia, chief executive of the International Swaps and Derivatives Association wants from regulators as Isda heads into its thirtieth annual general meeting, with post-crisis reforms still the industry's biggest headache.

"Now would be the right moment to call time out, assess where we are and do both the quantitative and qualitative assessments of what this market looks like before we take further steps. Everybody's looking at the individual rules and there's no analysis of the cumulative effect of all of this," he says.

As one example of that cumulative effect, O'Malia points to the rumbling debate about market fragility, specifically whether new capital, leverage and proprietary trading rules are crimping banks' ability to provide liquidity, what impact this is having during periods of stress, and how market structure needs to change in response. Banks often put the blame on regulation, while regulators argue it is appropriate for more risk to reside with investors. Both sides may be correct, of course, but whatever the rights and wrongs, all stakeholders share an interest in avoiding a catastrophic meltdown in the period before markets are able to adjust to the multi-layered new regulatory environment.

"What does risk management look like in this new space? Are we going to have fewer players, therefore concentrating the risk?" O'Malia asks. "There was some thought that by introducing mandatory clearing you would have the buy side stepping in to make markets and there would be competition in this space. I don't think we see that yet. So, if ultimately it's the same dealers making markets – or fewer dealers, due to high capital charges – is that the outcome we wanted?"

The exception that proves the rule in this case is Citadel. The Chicago-based asset manager and market-maker has a six-month-old swaps business, but other firms are yet to commit in the same way, and more opportunistic liquidity provision by buy-side firms is a rarity.

I haven't said undo all of this. I'm saying fix the errors

"If there's only one firm participating in a significant way, I don't think we've achieved the intended goal of those driving the regulatory initiative back in 2010-2012," says O'Malia. And he should know, having served as a commissioner of the Commodity Futures Trading Commission (CFTC) between 2009 and 2014.

It's not just the cumulative effects of regulation that O'Malia worries about – some of the individual strands are problematic in their own right. Swap data reporting is a particular bugbear for the Isda chief, partly because his time at the CFTC involved him in guiding and vetting the US version of that regime. Other jurisdictions have since put in place their own versions, introducing contradictions and confusion that have so far prevented regulators from getting close to their dream of being able to aggregate and compare swap data on a global basis; in the US, even the separate rules promulgated by the CFTC and the Securities and Exchange Commission clash.

Isda suggested a way to fix these problems in a February white paper, and O'Malia argues the association can play the role of trouble-shooter and path-smoother effectively. Last month, it also published a 'path forward' for swap execution rules, which already exist in the US and will be mirrored to a greater or lesser extent in at least the European Union and Japan. O'Malia argues Isda, which sees itself as the industry's steward for the global derivatives market, is ideally placed to solve the problems of not-quite-meshing international reforms.

But will regulators listen to the industry's diagnosis and follow its course of treatment? O'Malia admits the association has vested interests, but argues they are aligned with regulators' own: "Nobody comes at these issues in a completely disinterested, unbiased fashion. Everybody has an interest or a role in the market. We want to see good, efficient, safe markets, and we believe we have something to offer – some experience and expertise to bring to the table – and we want to do so in a data-driven, fact-based way."

In addition, he insists Isda is not trying to roll back the reforms: "I haven't said repeal the rules; I haven't said undo all of this. I'm saying fix the errors, fix the unintended consequences."

One of Isda's big achievements last year was the so-called resolution stay protocol – a document that is designed to give officials some breathing space if and when they need to resolve a stricken dealer. Signatories temporarily give up their right to terminate over-the-counter derivatives in the event of a counterparty's default, and 18 big dealers signed voluntarily in October last year.

Some of the shine was taken off by the reaction of the buy side, however, with investors and their lawyers complaining they had been left in the dark about the details of the protocol, and plans to roll out the framework to cover them this year. O'Malia responds that buy-side firms and associations were involved throughout, and points out that the expansion of the regime will be done via regulation, allowing investors to voice their opinions on its design.

But it is a reminder of persistent criticism that Isda is a dealer-dominated organisation – its 25-strong board contains only three buy-side representatives. O'Malia says the association has considered expanding buy-side representation at board level, but adds the current balance is good and argues investors already have the chance to make their voices heard through Isda's working groups.

"We have all walks of life as part of our membership. I take that very seriously and in the reforms we're making to the organisation and the working groups, that is a key priority that has to be maintained. They have to feel like their voice and their vote matters, and that they're getting the results they hope for," O'Malia says.

On the stay protocol specifically, he says: "I don't think anyone could fault Isda for not including people at the table. I think we have done very well to represent the buy side and to continue ensuring they have a voice in this discussion."