Designing data reporting requirements for OTC derivatives
The G20 agenda calls for over-the-counter (OTC) derivative traders to be required to report transaction level data to trade repositories (TRs) to improve transparency in OTC markets. New proposals put forward by a joint task force of the Bank for International Settlements (BIS) and the International Organisation of Securities Commissions (IOSCO) recommend detailed measures on OTC reporting to TRs, which will affect all financial institutions.
The task force has recommended that trade repositories and supervisors should have access to the following data on OTC derivative trades:
- transaction economics
- counterparty information
- underlier information
- operational data
- event data.
It believes that certain information not currently reported to TRs, such as master agreements and credit support annexes should be made available to supervisors to help facilitate the detection and consideration of possible affiliations between trading counterparties. In particular, this additional information may be relevant for data aggregation along with:
- legal entity identification (LEI): the task force proposes establishing a global legal entity identification system, which will enable stakeholders to efficiently identify the counterparties to OTC derivative transactions. In the absence of a global system, authorities and firms have created a variety of limited or proprietary identifiers, but the task force believes that the current patchwork approach is insufficient given the international and interconnected nature of OTC derivative transactions; and
- systems of product classification: the task force is calling on industry, in consultation with supervisors, to develop a standard product classification system that can be used as a common basis for classifying and describing OTC derivative products.
Defining the operational parameters of TRs is also critical to the success of the new reporting system. The task force would like to see internationally agreed principles which formally outline the level of access that authorities (i.e. market regulators, central banks, resolution authorities) have to all or part of the data reported to TRs. TRs should implement measures to provide effective and practical access to supervisors both on a routine and ad-hoc basis. In addition, reporting entities and counterparties should have appropriate access to their own data held by TRs, subject to confidentiality and other legal considerations.
While not surprising, the proposed reporting requirements are far-reaching and, if adopted, financial institutions will face significant costs in the coming years to build technology and operational systems to ensure compliance with new data reporting requirements. However, the proposed changes may also present a number of benefits to firms; for example, the mechanisms designed to support data aggregation will reduce inefficiencies associated with identifying the counterparties to OTC derivative transactions.
Given the importance of these proposed changes, industry needs to engage with the consultation process, which closes on 23 September 2011
, to help bring about effective solutions advantageous that work for both supervisors and firms. The G20 have made a firm commitment that all OTC derivative contracts should be reported to TRs. This commitment is reflected in the EU Regulation on OTC derivatives, central counterparties and trade repositories (EMIR), which is close to adoption. Greater transparency is necessary on OTC derivative markets, as the demise of Lehman Brothers and near-default of AIG and Bear Stearns evidence. However, supervisors are aware that they need to strike the right balance between enhanced transparency and unnecessary burdens to industry.
ESMA consults on AIFMD third country issues
ESMA has issued further proposals for the Level 2 implementing measures for the Alternative Investment Fund Manager Directive (AIFMD) on arrangements for delegation of portfolio management and risk management to entities in third countries, on supervisory arrangements between the EU and third countries, and on the appointment of non-EU depositaries.
Mangers will face an additional requirement when they delegate portfolio or risk management functions for an alternative investment fund (AIF) to an investment advisor, depositary or other service provider in a non-EU country, and to any sub-delegation arrangements. ESMA wants to require written agreements would be required between the competent authorities of the relevant third country and the AIFM’s EU member state, because these are core functions with a direct impact on investor protection and containment of systemic risk. The detailed content of these agreements would be based on existing ISOCO standard agreements on consultation, co-operation and the exchange of information between regulators, and would provide for on-site inspections, access to information on demand and assurance that enforcement action will be taken where a breach of regulations occurs.
A manager’s ability to delegate will also depend on an equivalence assessment, based on comparing the eligibility criteria and the on-going operating conditions that apply to the delegate under the third country’s regime to those that would apply in the EU. Any delegates which were not locally authorised or registered for asset management would also require approval by the competent authority of the manager’s EU home member state.
Similarly, depositaries in non-EU countries would be assessed on equivalence criteria, which are likely to prove challenging in practice. ESMA sets out the elements to be taken into account when assessing whether a third country depositary’s prudential regulation and supervision has the same effect as under AIFMD, and determining whether the third country regime is effectively enforced. In particular:
- the depositary should be authorised and regulated by an independent regulatory authority
- the local regulatory framework should set out criteria for being a depositary that are equivalent to those for an EU credit institution or investment firm
- capital requirements and operating conditions in the third country should be equivalent to those in the EU
- a local depositary’s specific duties should be equivalent to those under AIMFD
- effective deterrents should exist to discourage violations of the local regulatory requirements
- liability to investors in an AIF should be able to be invoked either directly or indirectly through the AIFM.
Requirements to have supervisory co-operation arrangements in place would also apply to depositary arrangements.
ESMA has a preference for a single agreement for each third country, which it would negotiate, to ensure a level playing field and to avoid the need for third party regulators to conclude different bilateral co-operation agreements.
Steven Maijoor, the ESMA Chair, in a press release accompanying the consultation document, stressed the importance of third-country and supervisory cooperation aspects of AIFMD, noting that both from the perspective of day-to-day supervision as well as systemic risk, it is essential the arrangements with non-EU competent authorities work “smoothly” and facilitate the exchange of information.
The consultation period closes on 23 September 2011, after which ESMA will review responses, amend its advice in light of them with the objective of delivering its final advice to the Commission by 16 November 2011. The current expectation is that the Commission will adopt implementing measures, based on ESMA’s advice in mid to late 2012. Member states are required to implement the AIFMD by 22 July 2013.
Lagarde calls for urgent recapitalisation of European banks
Christine Lagarde, Managing Director of the International Monetary Fund, has called for “decisive action” to mitigate the real risks of contagion and a full blown liquidity crisis in the European banking system, in a speech at Jackson Hole, Wyoming.
First and foremost, EU banks need urgent, substantial recapitalisation, according to the former French Minister of Finance, to buffer banks’ balance sheets and enable them to withstand the risks of sovereign default and weak growth in the global economy, possibly even using further public funds. While private funds should be used when possible, Lagarde believes that the European Financial Stability Fund or a similar Europe-wide funding scheme could be “mobilised” to recapitalise banks directly using public funds. This approach would avoid placing additional strains on already vulnerable member states, if banks were unable to raise funds at sustainable rates in financial markets.
More generally, Lagarde believes there are some “serious flaws” in the current architecture of the eurozone which threaten the viability of the entire project. European regulators and authorities need to recommit to a common vision of the eurozone with tighter fiscal and regulatory integration, which is built on solid foundations — including, for example, the creation of a single rule book for regulation in the EU which the European Supervisory Authorities are trying to propagate.