There is no global financial regulation – it’s regional authorities implementing regulations at the same time

One Change Leads to Another Connected Changes Words

The world is a very heterogeneous place characterised by a strong variety in each and every aspect. However, despite all the differences with regard to culture, business conduct, perceptions, etc. all participants of the global financial markets actually share a quite homogeneous challenge: “The global financial market reforms”.

It all started in September 2009, when the G20 Pittsburgh Summit reacted to the global financial crisis of 2008. Key aim of the resolutions was to enhance financial stability and to reduce systemic risk of financial institutions. The summit identified OTC derivatives to be of particular importance or, if you will, danger. Therefore, the summit concluded with several key commitments, containing that:

  • Certain types of OTC derivatives shall be traded on electronic trading platforms
  • Certain types of OTC derivatives shall be cleared through central counterparties
  • OTC derivatives shall be reported to designated reporting facilities
  • Non-centrally cleared deals shall be subject to higher capital requirements

Those are the key resolutions. So far, so good. However, it is not as simple as it might seem. And that is due to the fact, that the G20 Summit is not in the position to dictate law – the function of the G20 can rather be understood as the general direction provider or the definer of the ultimate goal.

The G20 created generally accepted provisions, and of course all participating countries are obliged to fulfil those. However, those provisions are not the law and neither do they specify the way, how to implement them. The law is being made on regional level and the standards of implementation as well. It is certainly no surprise that those could differ strongly. And, in fact, they do.

In the US, we have title VII of the Dodd-Frank Act regulating most of the above-mentioned provisions. In the EU it is a combination of EMIR (the European Market Infrastructure Regulation) and MiFID II (the reworked Markets in Financial Instruments Directive & Regulation) which is in charge of reforming the derivative markets. However, in Asia there is no such thing as one reform covering all the different states. It is practically the case, that each jurisdiction has its own approach.

Although the various regulations are in principle very similar, there are some significant deviations in the details of each regulatory initiative.

One of the major differences is the scope of products regulated by the initiatives. While Title VII of Dodd-Frank merely focuses on OTC derivatives, EMIR and MiFID II explicitly regulate both, OTC- and exchange traded derivatives.

Looking at the timelines, we can also observe some discrepancies regarding the effective dates of the implementation and classifications of market participants. US rule makers distinguish between three types of market players – the Swap Dealers (SDs), the Major Swap Participants (MSPs) and non-SDs/MSPs. For each classification there is an individual timeline for clearing and reporting obligations. Phased-in reporting has started from January 1, 2013 and phased-in mandatory clearing has started on March 11, 2013.

In contrast, EU rule makers do not distinguish between market participants but define one valid time line for all active players. Those will have to start mandatory reporting phased-in from July 1, 2013 at the earliest but most likely not before September 2013. As of today, it is not even clear when mandatory clearing will become effective for which products.

In addition, the reporting obligation in the US is one-sided and based on the hierarchy of the counterparties. This means, that only the higher-level participant has to report. So basically smaller parties, such as community banks and end-users, are excluded from the reporting obligation whatsoever. In the EU, both parties are subject to accurate reporting regardless of the enterprise size or position within the market. Apart from the reporting counterparty, there are also disparities regarding the reportable data. EU players will have to comply with more detailed reporting requirements than US ones, involving more extensive counterparty information, trading activity information and collateral data.

These examples illustrate some of the fundamental differences regarding the OTC derivatives reform as implemented in Europe and the US. However, the actual list of differences is even more exhaustive and one could easily fill many more pages.

What is important to understand is that there is no unique, unified, centrally orchestrated and standardized global financial regulation – it´s simply regional authorities implementing regulations at the same time. This of course leaves a huge gap which can be an opportunity for some but a major threat for most – regulatory arbitrage.