Including updates on mandatory clearing and MiFID


IOSCO outlines requirements for mandatory clearing

Banks and clearing houses should work together to decide which products should be centrally cleared, according to a new report from the International Organisation of Securities Commissions (IOSCO). According to this ‘bottom-up’ approach, a clearing house informs its regulator of all the products it clears or intends to clear, the regulator then considers if a mandatory clearing obligation should be imposed in relation to those products based on a number of considerations (including systemic risk, market abuse etc.).

In contrast, in a ‘top down’ approach the regulator would mandate the requirement after having identified which products are suitable for mandatory clearing, regardless of whether or not a clearing house has proposed to clear them. IOSCO stresses that this approach only provides a list of ‘potential products’ which may be subjected to mandatory clearing. The final decision would then be taken by the regulator on product-by-product basis.

IOSCO believes that authorities should use the ‘bottom up’ approach to the extent permitted by their legislative frameworks. However, a combination of both approaches--which is being pursued in many jurisdictions, including the European Union (EU)--would also work well. When adopting this mixed approach, the regulator would have adequate control over the framework but it would still be pretty fluid to enable it to continually capture and identify a maximum range of products to be considered for mandatory clearing.

IOSCO wants regulators to consult closely with industry stakeholders before deciding which products should be subjected to mandatory clearing--particularly in relation to the ‘top down’ approach. When the regulator makes a decision, it should disseminate clear information on requirements throughout the market place and give sufficient time to all relevant parties to prepare for associated changes.

IOSCO calls for a practical and proportional approach to clearing obligations, suggesting regulators may need to consider different implementation dates for different types of market participants. However, it notes that this phased approach is only viable if it is easy to categorise market participants and provided it does not allow regulatory arbitrage or facilitate firms avoiding mandatory clearing on either a temporary or permanent basis.

Regulatory arbitrage on a larger scale is a wider concern for IOSCO. Legislative changes and proposals to mandate central clearing are underway in a number of countries/regions. These changes and proposals are currently at various stages of development, ranging from initial consultation (e.g. Hong Kong, Australia, Russia) to legislation in others (e.g. EU, US). As countries further flesh-out their mandatory clearing regime IOSCO warns that divergence is probable. In addition to its own monitoring programme, IOSCO recommends that authorities coordinate by identifying ‘overlaps, conflicts and gaps’ between mandatory clearing regimes with respect to cross-border application of the clearing obligation.

When the regime is up-and-running, regulators will find it difficult to gain a ‘truly global picture’ of mandatory clearing given the propagation of information silos across multiple trade repositories (which are mandated to collect information on clearing), according to IOSCO. Market participants face a similar problem, especially those with global operations, as they try to assess which clearing obligations are applicable to them. Piecing together information from a range of sources is not desirable and IOSCO is keen to explore ways to consolidate information.

One proposal is establishing an online central information repository which would collect data from all trade repositories and make this publicly available but with confidential information restricted to regulators. IOSCO will undertake a feasibility study to determine whether regulators and market participants would obtain a net benefit if such an approach were adopted.

G20 members, at the summit of finance ministers and central bank governors in Mexico on 25/26 February, reconfirmed their commitment to ensuring that all standardised OTC derivatives are cleared by the end of this year. However, getting the new regime operational and working effectively on time is a significant challenge, on a domestic level. The challenges of ensuring consistency and compatibility of regimes on a regional and global level are likely to test securities regulators’ capacity for cooperation quite severely in the coming years.


ESMA stakeholder group response to MiFID consultations

In February the ESMA securities and markets stakeholder group (SMSG) published its responses to two recent ESMA consultations to update MiFID (I) on suitability and compliance rules respectively. The SMSG was set up to help facilitate consultation with stakeholders in areas relevant to the tasks of ESMA.

In terms of suitability, ESMA believes that recent evidence and supervisory experience suggests that firms are not complying consistently with MiFID suitability requirements across the EEA, citing information gathering, assessment of client information, risk profiling, and record keeping practices as weak areas. Therefore, to address these weaknesses, ESMA considered the following areas in its December consultation:
  • information provided to clients about the suitability assessment
  • arrangements necessary to understand clients and investments
  • qualifications of investment firm staff
  • extent of information to be collected from clients
  • reliability of client information
  • updating client information
  • client information for legal entities or groups
  • arrangements necessary to ensure the suitability of an investment and
  • record keeping.
On this consultation, SMSG advised ESMA that the guidelines should apply to all investment products, that discussion and interaction are the preferred methods of establishing client information and that advisers should have appropriate skills and responsibilities, similar to those established in the UK under the retail distribution review (RDR) regime.

In terms of compliance functions consultation, ESMA believes financial crisis highlighted the need for investment firms to provide better and tighter monitoring and risk management, including managing reputational risk, and to have a more comprehensive and proactive compliance strategy. Therefore, the guidelines seek to “enhance clarity and foster convergence in the implementation of the MiFID organisational requirements relating to certain aspects of the compliance function”. The consultation contained:
  • draft guidelines for firms on compliance monitoring, reporting and advising
  • draft guidelines for firms on the organisational requirements of the compliance function (standards of effectiveness, permanence and independence, and the interaction between compliance and other risk functions) and
  • proposed approaches for competent authorities reviewing compliance functions.
SMSG’s response to this consultation focuses on proportionality and seeks to ensure that ESMA’s requirements are not so substantial that they preclude small and medium-sized investment firms from entering the market. However, SMSG acknowledges that ‘staff headcount should not be used as a justification for not having an adequate compliance function’.

Both consultations closed on 24 February 2012. ESMA expects to publish its final guidelines on suitability and compliance in the next few months.