Posted by Richard Raeburn on his EACT Blog:
There’s an enormous amount happening on all economic and financial fronts as I write – with the equity and other markets in freefall and the USD soaring – so I am almost reluctant to blog again about OTC derivatives. In addition I am about to go to Prague for the latest (six monthly) EACT meeting. But I do think we are approaching the beginning of a very extended end-game on derivatives regulation, so here briefly are some not totally random thoughts.
We are about to be faced with a further consultation by the European Commission on its regulatory proposals (now branded as ‘EMIL’). Depending a little on whom you talk to, you may believe that the fact there is this further consultation reflects an acceptance by the Commission that the views of non-financial end users need a further airing. I suspect that the consultation is part of a long-planned process, at the end of which the Commission staff will be more than happy to hand over the topic to ESMA and other interested parties for the real implementation.
There is increasing transparency (to coin a phrase) on what will be involved going forward. The main elements that I have gathered are as follows.
The consultation is almost certain to propose that corporates are out-of-scope of the regulatory initiative – so no central clearing, cash collateral etc etc – unless a local regulator considers that hedging activities breach an investigation threshold. If that happens there will be a friendly conversation with the regulator, at which the corporate should focus on explaining the rationale for its activity; if I have been right in a lot of what I have been saying (when given the chance) the conversation will be almost entirely about risk mitigation.
If activity breaches a second and higher level then there will be a more searching – but retrospective – examination of the transactions around the legitimacy of the hedging. Systemic risk will be strongly on the minds of the regulator and I assume that if the examination fails to convince the authorities, there will be some sanction in the form of obligatory central clearing.
The devil is of course in the detail and that’s where it seems to me that ESMA and the national regulators will have a huge challenge. The particular elephant in the regulatory room is the notion of systemic risk and how that can relate to the higher of the two thresholds. The overall approach is based around the concept that that the Commission team has been talking about publicly, which is that the lower threshold is ‘qualitative’ and the higher is ‘quantitative’.
So….we need to get through what we expect to be a short consultation period with the Commission; then – whilst the rest of the Brussels governance structure turns it wheels on the Commission’s output – focus even more on what is happening on CRD IV and the BIS work to produce Basel III. The core concern here remains: what we may be in the process of winning with the OTC regulatory discussions we may promptly lose, with the application of what officials in Brussels have in the past happily described to me as ‘punitive’ capital requirements to sweep away the remaining OTC market.
In brief that is where we seem to be. The EACT meeting will be discussing the topic amongst many others over the next two days in Prague. We are also planning to mobilise additional resources, in common with some larger individual corporates, to ensure that the concerns of end users are probably articulated and communicated in Brussels and elsewhere.