SWISS DERIVATIVES. Review. Regulation. Water. Focus. Special ISSUE 44 AUTUMN 2010

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1 SWISS DERIVATIVES ISSUE 44 AUTUMN 2010 Review Focus Regulation Special Water Official publication of the Swiss Futures and Options Association, SFOA.

2 It seems strange, but by improving market safety, we ve improved market opportunity. As recent events have shown, safer markets are needed if derivatives are to deliver their full economic benefits. Asafer derivatives market is transparent, to inspire trust. It s efficient, so processes are simple and capital costs are lower. Itensures investors positions are protected. And above all it s neutral, so that counterparty risk is mitigated. Which is exactly what Eurex Clearing helps to provide. Eurex Clearing is Europe s largest CCP clearing house for securities and derivatives transactions. We process gross risks valued at almost EUR 9trillion every month across awide range of asset classes both on-exchange and off-exchange. At the same time, we re the first clearing house to deliver real-time risk monitoring for derivatives. We re also working with regulators and participants around the world to find ways to make markets safer. Because the more people have faith in the markets, the more they ll feel clear to trade.

3 Table of Contents Issue 44 Autumn 2010 Circulation and Print Run 10,000 Total estimated readers >20,000 Publisher, Advertisement, Subscription Weber-Thedy AG Corporate &Financial Communications Timo Kueng, Claudia Keller Zeltweg 25, CH-8032 Zurich, Switzerland Phone Fax Production Schwabe AG Farnsburgerstrasse 8,CH-4132 Muttenz Phone Fax Official Publication of SWISS FUTURES AND OPTIONS ASSOCIATION SFOA Swiss Futures and Options Association Ms. Carol Gregoir, Secretary General 18b, rue dugothard, P.O. Box 325 CH-1225 Chêne-Bourg, Switzerland Phone Fax AFM Association of Futures Markets Ms. Krisztina Kasza, Secretary General Rácz Aladár út Budapest /Hungary Phone /www.afmorg.net SAMT Swiss Association of Market Technicians c/o Daniel Stillhart P.O. Box 1007 Verenagasse 9 CH-8302 Kloten, Switzerland Phone: Cover picture Water drop Editorial Paul Meier, SFOA 5 Focus Regulation The Regulation of OTC Derivative Clearing and Reporting in the EU 6 Patrick Pearson, EU Commission Recent and Expected Regulatory Reforms 10 Richard Heckinger, Federal Reserve Bank of Chicago Regulating Derivatives: Safety, But How Much Diversity and at What Cost? 14 Anthony Belchambers, FOA Segregation Does it Deliver What it Should? 18 Richard Everett, Lawrence Graham LLP Event Review of the 31th SFOA Derivatives Conference in Interlaken 20 Geostrategic Challenges for the Coming Decade 28 Norbert Walter, Walter &Daughters Consult Emerging Markets Forum in Interlaken 34 Krisztina Kasza, Association of Futures Markets Transferring the Spirit of Bürgenstock to the World of Structured Products 37 Christian Reuss, Scoach Futures for Kids Giving Something Back 38 Special Water The Water Problem is Much Worse than Climate Change 40 Peter Brabeck, Nestlé The Water Industry: Why Investors Are Getting their Feet Wet 42 Mark Abssy, ISE Outline for an Ethical Water Futures Market 44 Valerie Issumo, Steve Ntifo and Olivier Champagne Agenda 46 Currency The Future of the Euro 48 Dr. Andreas Hoefert, UBS Wealth Management Education Algorithmic Trading New Assets, New Techniques and New Technology 50 Hirander Misra, Algo Technologies Ltd Exchanges Volatility Trading: VolContracts Jump into the Mix 52 Donald Schlesinger and Robert Krause, The Volatility Exchange Group WTI Remains the Benchmark of Choice for Crude Traders and Hedgers 55 Dr Robert Levin, CME Profile Eurex Innovate: a New Forum for Collective Innovation 57 Mehtap Dinc and Holger Stürtz, Eurex Exchange Cinnober: Delivering Marketplace Technology that Thrives on Change 58 Nils-Robert Persson, Cinnober Financial Technology Contents 3

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5 Dear Members and Friends of the SFOA Editorial Dear Members and Friends of SFOA, 5 The 31st Bürgenstock Conference is history. It was a successful event, not only full of interesting panels and keynotes but also social events, which made networking very easy. Meeting old and making new acquaintances and friends is one of the prime reasons for our conference this makes information sharing and discussion of issues much easier! The better informed we are the better we can serve our industry! Obviously, the nice weather and surroundings had their part in the success! A great thank you goes to all participants. Avery special thank you, of course, goes to our CEO Paul-André Jacot and Secretary General Carol Gregoir (supported by their Dream Team during the conference) for their great job again this year! A propos Carol Gregoir: we celebrated her 20th anniversary as Secretary General of SFOA in Interlaken. Her great work and dedication is one of the reasons for the success of our organization and the Bürgenstock conference in particular. Thank you very much, Carol, and looking forward to many more successful years! You will find areview of the conference in this issue, including look-backs on the Structured Products and Emerging Markets Forums. It was agreat pleasure to have the first Structured Product Forum as apre-conference part and from what Ihear it went very well. Ihope that it will become afixture in our program, just as is the Emerging Market Forum (along with the Regulators Meeting!). To us it is very important that the dialogue between these different market segments be cultivated as it is key to the success of all involved! Additionally you will find other very interesting topics in this issue of the SDR; abig thank you to all the advertisers who make this publication possible. Iwish you alot of reading pleasure! The year-end is drawing very fast, frighteningly fast we just celebrated New Years, didn t we?? A very eventful year is drawing to a close, a year where we received a lot of support from many of you thank you very much!! Without your support we could not survive. I trust that we can count on you again in I wish you a great last quarter and all the best for a happy, successful and healthy 2011! Sincerely Paul Meier Chairman

6 Focus Regulation The Regulation of OTC Derivative Clearing and Reporting in the EU The OTC derivative markets have been at the centre of regulation efforts since their role became evident in the fall of Bear Sterns. International commitment to improve transparency has been confirmed repeatedly and the Commission s services have taken up this task in consultation with a broad range of stakeholders. 6 OTC derivatives benefit financial markets and the wider economy by improving the pricing of risk, adding to liquidity, and helping market participants manage their respective risks. The recent financial crisis exposed weaknesses in the structure of the OTC derivatives markets that had contributed to the buildup of systemic risk. While markets in certain OTC derivatives asset classes continued to function well throughout the crisis, the crisis demonstrated the contagion effect arising from the interconnectedness of OTC derivatives market participants and the limited transparency of counterparty relationships. It is important to address the weaknesses in these markets which exacerbated the financial crisis. Since October 2008, the Commission s services have been engaged in continual, extensive consultation with stakeholders to determine the appropriate policy response. Initially the Commission services attention focused solely on the Credit Default Swap (CDS) market which was at the centre of attention with Bear Sterns and Lehman s. In order to facilitate the monitoring of the major dealers commitment in this area, the Commission established aderivatives Working Group (DWG), that included representatives from the financial institutions that committed to clear European referenced CDS by July 2009, representatives from central counterparties, trade repositories and other relevant market participants and from relevant European (ECB, CESR, CEBS and CEIOPS) and national (AMF, BaFin and FSA) authorities. In addition to the meetings of the DWG, the Commission held separate, ad-hoc bilateral and multilateral meetings with a large number of stakeholders. Importantly, in September 2009, G20 Leaders agreed in Pittsburgh that: All standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end at the latest. OTC derivative contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements. In June 2010, G20 Leaders in Toronto reaffirmed their commitment and also committed to accelerate the implementation G20 Leaders committed to improve transparency and regulatory oversight of over-the-counter derivatives in an internationally consistent and nondiscriminatory way. of strong measures to improve transparency and regulatory oversight of over-the-counter derivatives in an internationally consistent and non-discriminatory way. On 20 October 2009, the Commission adopted a Communication that set out the future policy actions the Commission intended to propose to increase transparency of the derivatives market, reduce counterparty and operational risk in trading and enhance market integrity and oversight. That Communication also announced the Commission s intention to proceed with legislative proposals in 2010, to ensure the implementation of the G20 commitments to clear standardised derivatives and that Central Counterparties (CCPs) comply with high prudential standards and adequate regulation of trade repositories. The European Commission s legislative proposal (in short: european market infrastructure regulation EMIR) of15september 2010 to implement the G20 commitments is aclear and firm step forwards to introduce more safety and transparency in the financial system. The legal form of EMIR is important: it is aregulation based on Article 114 TFEU as opposed to the traditional legal act (a Directive). ARegulation is considered to be the most appropriate legal instrument to introduce a mandatory requirement directed to all actors to clear standardised OTC derivatives through CCPs and to ensure that CCPs, that will as a consequence assume and concentrate significant risk, are subject to uniform prudential standards in the EU. In contrast to adirective, aregulation does not need to be transposed into 27 Member State laws. It is directly applicable in the legal systems of the Member States and introduces obligations and rights that can be directly invoked before the national courts. As a Regulation will not require transposition into national law aprocess that requires at least 18 months itcan acquire the force of law in ashorter timeframe. To help mitigate risk in the OTC derivatives markets, EMIR requires all standardised derivatives contracts that are eligible for clearing to be cleared through central counterparties. In order to establish a process that ensures that as many OTC contracts as possible will be cleared, the Regulation introduces two approaches to determine which contracts must be cleared:

7 Focus Regulation a bottom-up approach, according to which a CCP decides to clear certain contracts and is authorised to do so by its competent authority, who is then obliged to inform ESMA once it approves the CCP to clear those contracts. ESMA will then have the powers to decide whether aclearing obligation should apply to all of those contracts in the EU. ESMA will need to base that decision on certain objective criteria; a top-down approach according to which ESMA, together with the European Systemic Risk Board, will determine which contracts should potentially be subject to the clearing obligation. This process is important to identify and capture those contracts in the market that are not yet being cleared by a CCP. Both approaches are necessary because, on the one hand, meeting the G20 clearing commitment cannot be left entirely to the initiative of the industry. On the other hand, aregulatory check at European level of the appropriateness of certain arrangements is necessary before the clearing obligation enters into force. It is important to note that counterparties that are subjected to the clearing obligation cannot simply avoid the requirement by deciding not to participate in accp. If those counterparties do not meet the participation requirements or are not interested in becoming clearing members, they must enter into the necessary arrangements with clearing members to access the CCP as clients. Furthermore, and in order to avoid the erection of barriers and to preserve the global nature of OTC derivatives, CCPs should not be allowed to accept only those transactions concluded on execution venues with which they have aprivileged relationship or which are part of the same group. For these reasons, accp that has been authorised to clear eligible derivative contracts is required to accept clearing such contracts on a non-discriminatory basis, regardless of the venue of execution. A specific treatment of non-financial counterparties has been included in EMIR. Depending on the circumstances, requiring all non-financial end-users to comply with mandatory clearing requirements may not be necessary to reduce systemic risk. Some may trade OTC derivatives predominantly to CCPs should not be allowed to accept only those transactions concluded on execution venues with which they have aprivileged relationship or which are part of the same group. hedge risk arising from their commercial activities, and this usage of OTC derivatives (where assets and hedges are inversely correlated in terms of value) typically represents a lower probability that the hedging firm s failure would create asignificant loss to the system were the firm to default. Furthermore, non-financial end-users may have difficulties accessing and financing the liquidity that is needed to meet the margin calls of a CCP resulting from its mark-to-market valuation of a particular contract. EMIR therefore exempts those non-financial end users from clearing if their exposures are below acritical threshold that will be set by ESMA and the new European Systemic Risk Board. (A reporting threshold, set at alower level, will require non-financial to report their OTC contracts to the regulatory authorities). Mandatory clearing of eligible standardised OTC contracts is part of acombination of measures. Noncentrally cleared bilateral contracts will be subject to higher capital requirements under Basel 3. In addition, for products that remain non-centrally cleared, EMIR sets strengthened bilateral counterparty risk management requirements. In view of the significant amounts of risk that will migrate to CCP s, EMIR also requires that they are subject to very high prudential requirements. ESMA will be tasked to set these standards. To ensure that CCPs established in the European Union are safe, the authorisation of accp will be subject to that CCP having access to adequate liquidity. Such liquidity could result from access to central bank or to creditworthy and reliable commercial bank liquidity, or a combination of both. Furthermore, national competent authorities should retain the responsibility for authorising (including withdrawal) and supervising CCPs, as they remain best placed to examine how the CCPs operate on a daily basis, to carry out regular reviews and to take appropriate action, where necessary. Given the systemic importance of CCPs and the cross-border nature of their activities, it is important that in the authorisation process acentral role is played by ESMA. This will be achieved in the following ways: the adoption of this legislative act in the specific form of a Regulation will give ESMA acentral role and responsibility 7

8 Focus Regulation 8 for ensuring its common and objective application, as clearly specified in the ESMA Regulation; ESMA will be required to develop a number of draft technical standards in critical areas for the correct application of the Regulation; ESMA will facilitate the adoption of an opinion by the college. As CCPs are considered to be systemically relevant institutions, the relevant competent authorities in the college of competent authorities must define contingency plans to cope with emergency situation. Furthermore, the Commission in its future initiative on crisis management and resolution will need to define the specific policy and measures to address a crisis situation in a systemically relevant institution. As regards CCPs from third countries, ESMA will also have the direct responsibility of recognising such CCPs, if certain conditions are met. In particular, the recognition will require that the Commission has ascertained the legal and supervisory framework of that third country as equivalent to the EU one, that the CCP is authorised and subject to effective supervision in that third country and ESMA has established cooperation arrangements with the third country competent authorities. A CCP of a third country will not be allowed to perform activities and services in the Union, if these conditions are not met. Finally, increased competition will be ensured in EMIR through interoperability arrangements between CCPs, subject however to regulatory approval. All of the measures described above are designed to increase the safety of the financial system. EMIR also contains important steps to increase transparency in the system. Because of the overwhelmingly bilateral nature of the OTC derivatives market, regulators currently do not have a practical means of acquiring a full picture of market participants direct and indirect counterparty credit risk exposures. This incomplete picture of risk exposures makes it difficult for regulators to gauge the concentration of risk-taking across markets. During times of stress, this incomplete picture of risk exposures also may complicate official sector actions to stabilise markets. EMIR therefore requires reporting, centralising the collection, storage and dissemination of information to trade repositories in a consistent fashion. Trade repositories will thus be able to fulfil an important function as acredible source of data on OTC derivatives transactions for authorities, market participants and the general public. Requiring reporting of OTC derivatives transactions to trade repositories can improve transparency to both regulators and the public, allowing authorities to address vulnerabilities in the financial system and develop well-informed regulatory, supervisory and other policies that promote financial stability and reduce systemic risk. Use of trade repository data will also enable authorities to better carry out their prudential supervision and resolution mandates. The European Commission s legislative proposal is part of a larger international effort to increase the stability of the financial system in general, and the OTC derivatives market in particular. Given the global nature of the OTC derivatives market an internationally coordinated approach is crucial. It is therefore important that an EU-proposal takes into account what other jurisdictions intend to do or have already done in the area of OTC derivatives regulation to avoid the risk of regulatory arbitrage. In this context, the Commission s proposal is consistent with the recently adopted US legislation on OTC derivatives, the so-called Frank-Dodd Act. The Act has a broadly identical scope of application. It contains similar provisions requiring the reporting of OTC derivative contracts and the clearing of eligible contracts. Furthermore, it puts in place strict capital and collateral requirements for OTC derivatives that remain bilaterally cleared. Finally, it puts in place a regulatory framework for trade repositories and upgrades the existing regulatory framework for CCPs. Similarly to the Commission s proposal, the Act foresees the further elaboration of a number of technical rules. Work at international level is continuing. In order to ensure a converged approach in the implementation of the G20 recommendations, the Financial Stability Board (FSB) established a working group to discuss and compare national implementation efforts. The working group, co-chaired by the SEC, the New York Federal Reserve Board and the European Commission, intends to report to the FSB plenary meeting on 20 October on how to address the challenges related to the implementation of the reporting, clearing and trading obligations agreed at G20 level. Patrick Pearson is Head of the Financial Market Infrastructure Unit at the Internal Market Directorate General of the European Commission in Brussels.

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10 Focus Regulation Recent and Expected Regulatory Reforms As the regulatory efforts, in particular on OTC derivatives have gone global, the following paper gives an overview of the latest or expected formulation and implementation of public policy mostly in the United States and Europe. 10 The recent financial crisis necessitated restructuring of the regulatory regimes covering the conduct of business in the financial services sector of the global economy. There has been no shortage of papers and symposia that have examined the causes of the financial crisis, and have attempted to identify the key factors and possible remedies that might prevent such events in the future. The overall regulatory agenda has moved beyond such analysis (although many papers, academic and commercially oriented, continue to be published) to the formulation and implementation of public policy. This paper reviews some of the regulatory initiatives that are in the process of implementation as well as some that are anticipated in the future. While the scope of the various regulatory initiatives is broad, this paper will focus primarily on those related to derivatives and financial market utilities (FMUs). G20 Objectives The key objectives of regulatory reform were stated succinctly by the G20 communiqué from the Pittsburgh Summit ,and reaffirmed at the subsequent summit in Toronto in : We are building a more resilient financial system that serves the needs of our economies, reduces moral hazard, limits the build up of systemic risk, and supports strong and stable economic growth. We have strengthened the global financial system by fortifying prudential oversight, improving risk management, promoting transparency, and reinforcing international cooperation. Further, This reform is to be built on four pillars, namely: 1. A strong regulatory framework, with emphasis on the oversight of hedge funds, credit rating agencies and overthe-counter (OTC) derivatives, to include accounting and compensation standards in the scope of such oversight. Particular emphasis is on capital and liquidity standards. 2. Effective supervision of institutions with particular focus on the risks they bear or create, and the promotion of early detection and intervention. 3. Effective resolution tools to allow for the work out or restructuring of financial institutions without the use of taxpayer money. 4. Transparent international assessment and peer review to prevent regulatory arbitrage. The G20 called on the cadre of international agencies and standards setting bodies for direct action on regulatory reform. For example, with regard to capital and liquidity standards, the Basel Committee on Banking and Supervision (BCBS) has the objective of reaching agreement on new capital framework at the Seoul Summit in November 2010, and in September 2010, the Basel III standards for bank capital were published. Similarly, the Financial Stability Board (FSB), in consultation with the International Monetary Fund (IMF), has been asked to report to the G20 Finance Ministers and Central Bank Governors in October 2010 on recommendations to strengthen oversight and supervision, especially as regards early identification of risks and principles for intervention. Overall, the G20 calls for most regulatory reforms to be implemented by the end of Focus on OTC derivatives The G20 specifically focused on OTC derivatives with the following statement of objectives: All standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest. OTC derivative contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements. We ask the FSB and its relevant members to assess regularly implementation and whether it is sufficient to improve transparency in the derivatives markets, mitigate systemic risk, and protect against market abuse. [Emphasis added] Work toward achieving several of these objectives has been in progress by various agencies. For example, the International Swaps and Derivatives Association (ISDA) has had initiatives going for some years to develop standard contract terms and documentation for OTC derivatives. Additional attention is directed to financial market infrastructure and the regulation of OTC derivatives products and users. As an extension of the existing processes in standards setting, consultative papers have been issued by regulators and standards setting bodies such as the Committee on Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO). Technical committees and working groups are revising existing or formulating new standards to cover the governance, structure and functions of FMUs such as payments systems, securities settlement systems and central counterparties (CCPs). Harmonization and coordination of data, technical and oversight standards are the objectives of the OTC Derivatives Regulators Forum (OTCDRF), agroup of about 45 securities regulators, central banks and pan-national agencies 3. While coordinated and harmonized standards are desirable for our globalized financial markets, they are not sufficient to effectively regulate the markets without the force of law. Consequently, legislation has been passed, or is in the process

11 Focus Regulation of passage, in several countries that will greatly affect how business is conducted and risks are handled in financial markets. Legislation and Rule Making Early in the analysis of the financial crisis it was generally understood that the scope of existing laws was not adequate to effectively regulate the financial markets, either locally or globally. Consequently, several nations and transnational jurisdictions have proposed or adopted legislation to restructure their regulation of financial markets. For those countries that have passed legislation the task now shifts to the writing of rules or regulations, as appropriate to the regulatory and legal structure, that will implement the law in practice. Japan In May 2010, Japan passed an amendment to the Financial Instruments and Exchange Act (Number 25 of 1948) that strengthens the infrastructure for domestic CCPs, recognizes foreign CCPs and develops asystem for links between domestic CCPs and foreign CCPs, all with respect to the clearing of Japan-related credit default swaps (CDS) and interest rate swaps (IRS). Detailed Japanese regulations will be published by the Japan Financial Services Agency (FSA) and are expected to be published in late 2010 by means of cabinet orders or cabinet office ordinances. United States (US) Similarly, in the US the Dodd-Frank Wall Street Reform and Consumer Protection Act (US Act) was signed into law in July that comprehensively restructures regulation of the US financial markets. Titles VII and VIII of the bill pertain to the regulation of OTC derivatives and additional regulatory oversight of systemically important FMUs. All OTC derivatives contracts must be reported to atrade repository (TR,) and standardized OTC derivatives contracts must be cleared by accp. Non-standardized contracts must be secured by collateral and capital charges. Considerable work remains to be done to write the rules specific to the authority and responsibility of the respective regulators. For example, the US Commodity Futures Trading Commission (CFTC) estimates that there are 80 to 100 rules, reports and studies (with the rules grouped into 30 areas of commonality) that must be completed within the 360 day period after enactment (21 July 2010) of the US Act. With respect to OTC derivatives both the CFTC and the Securities and Exchange Commission (SEC) need to write rules covering the trading, reporting and clearing of such contracts under their respective purviews. In addition, those agencies and the Federal Reserve must write or revise standards for oversight of FMUs. European Union (EU) The European Union published its legislative proposal covering financial markets in September The scope of the Regulation includes the regulation of OTC derivatives contracts and CCPs both in, and outside, the EU. Like the US Act, the EU Regulation requires additional regulatory oversight of systemically important FMUs. Reporting of OTC derivatives to atrismandatory, as is the use of accp for clearable OTC derivatives contracts. The adoption of an EU Regulation carries the force of law in each of the member countries therefore ensuring that the law will be applied uniformly. The EU Regulation calls for drafts of technical standards to be submitted for implementation by June 2011, with full implementation by Other EU standards are contained in the Markets in Financial Instruments Directive (MiFiD). MiFiD became effective in late 2007 and its scope covers many aspects of financial market operations. These included standards regarding transparency, reporting requirements (e.g., for OTC derivatives transactions and positions) and business conduct that were implemented in relation to market functions generally. United Kingdom (UK) The UK Treasury has published its proposal for reform of the UK regulatory structure 4 for consultation and submission of comments by mid-october The proposed legislation will broadly restructure the UK regulatory authorities responsibilities, as well as reorganize them administratively. Most notably, the UK Financial Services Authority (FSA) would cease to be aseparate regulatory body and become a subsidiary of the Bank of England as the Prudential Regulatory Authority (PRA) responsible for overall financial integrity of firms. In addition, anew agency, the Consumer Protection and Markets Authority (CPMA) will be established to oversee business conduct and wholesale market functions (i.e., market infrastructure) to include exchanges, CCPs, payments systems and settlement systems. Full statutory authority will be consummated when UK legislation is adopted, expected to be in early 2011, with formal adoption of rules imminent. As noted above, considerable effort is being made internationally to coordinate and harmonize rules among the various regulators. New Supervisory Authorities The EU Regulation and the US Act create new supervisory authorities. With regard to derivatives the EU will establish the European Securities and Markets Authority (ESMA). ESMA will coordinate its activities, such as the authorization of 11

12 Focus Regulation 12 FMUs, in consultation with a college of competent authorities whose membership will include the Member State regulators responsible for supervising the market, its users and the FMU in question, among others. Another supervisory body is the European Systemic Risk Board (ESRB) that will (from January 2011) be responsible for macro prudential oversight of the EU financial system. With respect to derivatives, ESMA will be responsible for determination of clearing eligibility of OTC derivatives, authorizing CCPs (to include third country CCPs) and the registration of TRs. In a similar fashion, the US Act creates the Financial Stability Oversight Council (Council). The purposes of the Council include identifying risks to the financial stability of the US that might arise from financial distress or failure of large interconnected bank holding companies or nonbank financial companies. With specific regard to FMUs, and among many other purposes, the Council is to identify systemically important FMUs and payment, clearing and settlement activities so that regulations applicable to FMUs with that status become effective. Systemically important FMUs will be granted access to certain central bank services and accounts, and will be subject to oversight by the Federal Reserve in addition to their primary regulators. As noted, above, there will be arestructuring of supervisory authorities in the UK, as well as the establishment of new ones (and the retirement of some legacy agencies). In addition to the changes mentioned, the Financial Policy Committee (FPC) will be established within the Bank of England, with responsibility for identifying imbalances, risks and vulnerabilities in the financial system and authority to take decisive action to mitigate these in order to protect the wider economy. Other supervisory agencies will be merged or created to cover such functions as consumer education, consumer credit and compensation schemes. Implementing the Regulatory Objectives So, how will these initiatives affect the derivatives markets in general, and the OTC markets in particular, in the months and years to come? To answer this question it is helpful to review the G20 s most key regulatory objectives, and describe the market developments that will be (or are being) pursued to achieve its objectives. Objective: Greater transparency in the price discovery and distribution of OTC derivatives To be achieved by: Mandatory registration of all OTC deals at atr, and data sharing and regulatory oversight agreements among regulators. Use of exchanges and/or trade execution facilities for price discovery, trade consummation and reconciliation. Objective: Increased level of standardization of OTC derivatives contracts To be achieved by: Furtherance of ISDA initiatives regarding documentation and dealer acceptance of more standard products. To further the expected benefits of standardization in the risk management area there are regulatory mandates/encouragements to clear standardized or clearable contracts at accp. Objective: Reduction of risks in the OTC derivatives markets To be achieved by: More use of CCPs to clear OTC contracts deemed to be standardized or clearable, or the exchange of collateral with capital charges for non-clearable OTC contracts. More systemic risk regulation by, for example, (US) Financial Stability Oversight Council, (EU) European Systemic Risk Board and the (UK) Financial Policy Committee, with other oversight by primary regulators. Objective: Minimize regulatory arbitrage To be achieved by: Ahigh degree of international coordination in the rule making process as well as in the setting of standards. In addition to comprehensive regulatory reform of rules and standards, successful implementation of these objectives is dependent on the development of significant market infrastructure in the form of FMUs. The use of atr(or several TRs) to record an OTC derivatives position is arelatively new development (for example, the TR for CDS positions Warehouse Trust was established in 2006), and new ones are in the process of being established across the range of OTC product types. Similarly, the clearing of OTC derivatives by one or more CCPs is arecent, and expected, development with new CCP service offerings in operation or under construction. More work remains in the development of transparent trading processes. Issues to Resolve The regulatory restructuring has just begun. Many of the rules and standards initiatives require consultations regarding the definitions and ways and means of implementing the proposed rules and standards. Even at present there are issues that are under discussion by concerned parties. Afew, among possibly many others, are described below. Definitions: 1. What is the meaning of a standardized or clearable OTC derivatives contract? Market participants have

13 Focus Regulation interest in how these terms are defined because their definition will affect financial and operational performance. In addition, new systems may have to be developed (such as back office straight through processes) to accommodate the requirement that clearable OTC products be guaranteed by a CCP. Similarly, CCPs have responded that they need to have the proper risk management in place to take on clearing OTC contracts, and it should be the CCP s decision as to what products it will clear. The regulatory mandates to use accp varies in among regulators, with the imperative stated either strongly or less so, and in terms of whether the approach will be top down (as in the EU) or bottom up (as in the US) where the CCP is allowed more discretion. 2. What is the meaning of buy-side or commercial user or major swaps participant? These categories are important to market users as they will define the regulatory (and possibly other, such as tax) status of the participant and the products they use. The impacts will be on the participants operations, risk management, capital charges and use of collateral. Access to FMUs 1. If the use of a TR is mandatory, then access to the single (or several) TR for aproduct type becomes critical to the users of the products. Access includes the possibility of direct participation or membership, connectivity and involvement in the governance of the TR. It is presently the norm that access to TRs is through intermediaries, and this arrangement, and the application of additional legal jurisdictions, privacy and data protection regimes that result from such intermediation are areas where additional oversight and coordination might be needed. 2. The use of CCPs is mandated or encouraged by regulators. It is expected that such amandate will be made in a jurisdiction that has no CCP for the OTC product type, thereby forcing the OTC market users into using a CCP in another jurisdiction, possibly through an intermediary and under a different set of legal, regulatory and bankruptcy codes. Extra layers of intermediation introduce costs and risk that might not need to be borne. However, duplicative market structures, such as FMUs, are expensive to develop and are not free of costs to operate. Governance 1. It has been suggested that certain kinds of financial market institutions should not own FMUs, or be limited to a certain concentration of ownership. For example, the question has been posed as to whether it is appropriate for banks to own CCPs. In addition, the question of ownership of FMUs by commercial firms might constitute conflicts of information or conflicts of interest with regard to operation of an FMU versus the firm s commercial interests. 2. The general question of governance stems from the question of the openness of a utility to any and all user, and the control of the FMU. One possible model is for FMUs to be public sector institutions; however, the financial market infrastructure already includes commercially oriented TRs and FMUs, and public ownership and operation introduces other issues. These and other issues will be subject to consultation with market users and the public so that the interests and opinions of each will be reflected in the rules and standards making process. Public Policy Benefits and Costs The financial crisis has brought about many changes in the financial markets, and it is clear that we are now in a period of rapid change in response to official initiatives and market responses. The benefits of regulatory restructuring are mostly assumed in the improvements expected from achieving stated objectives (e.g., reduction of systemic risk) while the costs of implementing the restructuring are not widely analyzed. What is clear is that this global implementation of public policy objectives will forever alter the uses and functions of our financial markets. 1 The Pittsburgh Summit 2009, at: center/ htm 2 The G-20 Toronto Summit, at: tion_en.pdf 3 OTC Derivatives Regulators Forum, Scope and Relationship with International Bodies, at: mar2010.pdf 4 A new regulatory approach to financial regulation, at: Richard Heckinger, Assistant Vice President and Senior Policy Advisor, Federal Reserve Bank of Chicago. The views expressed are the author s and do not necessarily reflect the views of the Federal Reserve Bank of Chicago or the Federal Reserve System. 13

14 Focus Regulation Regulating Derivatives: Safety, But How Much Diversity and at What Cost? As many stakeholders demand increased transparency on the OTC markets, one should not forget that consequential regulatory changes will be significant and expensive. The following article considers the impact of current initiatives on choice, diversity and innovation. 14 While it is true that, aside from credit derivatives, most OTC and exchange-traded derivative markets were not acause of the crisis and performed well through its cycle, it has highlighted the significant risk posed to the system by sudden falls in liquidity in the high-volume, deeply interconnected and underregulated OTC markets. The programme for consequential regulatory change will be significant and expensive and it will impact not just on the shape and functionality of markets, but on dealers, end-users and the economics of risk management. Some of the changes are of general application, but others have a specific derivatives focus. There is much to commend in the repair programme, but the understandable drive for safer markets and asounder system should not be bought at the price of reduced choice, diversity and innovation, all of which are critical to growth; and political populism and national protectionism should not be allowed to so colour the regulatory agenda as to make a business-sensitive approach impossible. Firstly, there are changes to the regulatory infrastructure. In the EU, this includes anew European Supervisory Markets Authority (ESMA), which will supervise the supervisors, ensure the harmonised implementation and enforcement of EU legislation, develop technical standards and, in due course, establish a single rulebook. However, there will be turf tensions upstream with the European Commission in terms of the development of regulatory policy and downstream with the member state supervisors in the area of supervision. ESMA has made no secret of its supervisory and regulatory ambitions. As it is, ESMA will (a) authorise and supervise trade repositories; (b) participate in the regulation of clearing houses; and (c) participate in the supervisory colleges responsible for overseeing systemically important European banks. Clearly, such a more centralist approach (including the wider use of directly applicable EU Regulations and the development of a single rulebook) could deliver real benefits in terms of regulatory harmonisation, but it also could be more consumerist and protectionist and less sympathetic to market realities. By way of contrast, the UK Financial Services Authority, while supporting many of the proposed changes to the regulation of the OTC markets, demonstrated its market understanding by opposing compelling CCP transactions to be centrally executed on regulated markets or MTFs, cautioning against the use of punitive capital rules, recognising the important role of financial traders in commodity markets and emphasising the market importance of short-selling. National structural changes are adding to the burden. For example, in the UK, the Government is consulting on dividing the FSA into aprudential Regulatory Authority, which will be responsible for the prudential regulation of key institutions, and a Consumer Protection and Markets Authority, which will be responsible for the prudential and business conduct regulation of non-systemically important institutions and the regulation of market infrastructures. Secondly, there are changes in EU directives and regulations. This includes the European Market Infrastructure Regulation (EMIR), the new MiFID Directive ( MiFID 2 ), new market abuse legislation and a revised approach to shortselling. The key focus of EMIR is on: establishing the processes and criteria by which OTC contracts will be deemed eligible for CCP clearing; setting high-level regulatory standards for CCPs covering, for example, capital, default funds, governance, conflicts of interest, risk management controls, segregation of client positions and assets and, in the event of default, the prompt transfer of positions and related collateral; setting basic regulatory standards for trade repositories, including OTC trade reporting, data confidentiality (other than to regulatory authorities) and public disclosure of aggregated data; establishing rights of clearing access to CCPs, aright of interoperability in relation to cash equities and fair and transparent pricing for CCP services; exempting non-financial end-users (subject to compliance with thresholds yet to be determined) from being compelled to centrally clear otherwise eligible OTC contracts; enhancing back-office processing of OTC transactions. While most of these requirements reflect good organisational and business practice, there are a number of key concerns. For example, tensions over whether or not the more difficult and higher-risk OTC contracts will be deemed eligible for CCP clearing and over whether the requirement for easier identification and ready access of collateral to ensure portability will limit the capital efficient use of collateral. As for MiFID 2, the need to review the original MiFID is selfevident greater competition between infrastructures, fragmentation of liquidity/prices, significant advances in technology (e.g. smart order routing, direct market access, high-frequency trading) and questions surrounding systematic internalisation, customer categorisation, complex/non-complex instruments, crossing networks and dark pools. Here again, change is inevitable. For derivatives, this will include new provisions regarding post-trade transparency of non-equity transactions and a review of commodity markets (including the current exemptions for specialist commodity dealers, the role of speculation and the use of position limits) and whether or not CCPcleared OTC transactions can continue to be traded bilaterally.

15 Focus Regulation The forthcoming market abuse legislation is likely to extend market abuse to cover trading on MTFs and in the OTC markets, and harmonise the approach to market abuse in financial and commodity markets and in derivative commodity markets and physical commodity markets. Few would quarrel with these changes, providing they are proportionate, market-sensitive and the concept of acceptable market differences continues unchanged. With regard to short-selling, the draft regulation, while not banning short-selling, empowers the authorities to prohibit it at times of market volatility and naked short-sellers will have to have arrangements in place to deal with settlement risk. While disclosure obligations to regulatory authorities are inevitable, the industry has expressed concern over whether the thresholds are set at the right level, particularly in relation to the publication of trades. Thirdly, there are changes in US regulation. There is no doubt that EU and US regulators have been working closely together and, in many respects, the EU and US approach to OTC markets is very similar, but there are differences. For example, major corporate users of swaps could find themselves directly regulated in the US, but, potentially, not in the EU and the EU may adopt amore flexible approach towards exempting non-financial users from the obligation to CCP-clear their OTC transactions. Unlike in the US, they may also be able to choose their preferred execution methodology for CCP-cleared transaction and it is also unlikely that the US push-out provisions and the ban on certain forms of proprietary trading by banks will be replicated in the EU. Then there is the question of position limits. While the CFTC will look to impose position limits in commodity markets to curb speculation, the EU may simply authorise member states to impose them, so allowing them to rely instead on position accountability and management. It is to be hoped that the extensive and commendable process of EU consultation will result in a more businessfriendly, but still more comprehensive regulation and supervision of the OTC markets. Regulatory consensus, while important, must not be bought at the price of damaging market functionality and it should be noted that, since the US has already passed its legislation, it will base its negotiating position largely on a do as we do approach. The EU, on the other hand, has yet to pass its legislation. This should mean that, if US law is perceived to damage market functionality or take away customer choice needlessly or impair the risk management capability of endusers, the Commission could adopt a differentiated regulatory approach. Finally, there are changes driven by increasing politicisation of the regulatory agenda. For example, early political pressure to require Euro-denominated contracts to be cleared by and reported to clearing houses and trade repositories within the Eurozone and to resist regulatory recognition of non-eu CCPs and trade repositories other than on the strictest terms reflecting the political objective to locate dealings in Euro-denominated OTC derivatives within the Eurozone. An equally protectionist approach was originally adopted towards CRAs and, in earlier drafts for an AIFM Directive, towards hedge funds. Another example of political populism is the debate over financial trading (or speculation ) in commodity markets. The inherent conflict is between regulatory authorities, whose role is to ensure that markets discover fair prices, and governments, which want markets to deliver low prices, particularly in consumer-sensitive commodities. This reflects the fact that, while governments may idealistically support the concept of free markets, they find it difficult to live with the consequences in terms of the discovery of uncomfortable prices and economic truths. The question is whether or not this is a back door attempt at price control. Of course, excessive speculation can have a distorted impact on prices, can generate short-term spikes in volatility and can exacerbate long-term pricing trends, but speculators are also critical to liquidity, are essential for taking the opposite position in risk-transfer trades and often eliminate and smooth out pricing discrepancies. Another element of how the agenda is being driven by political considerations is the wide powers that are being retained by the US to, for example, apply its prudential rules to non-us banks dealing with US customers, or its swap rules to non-us dealings where they impact US commerce or are evasive of CFTC requirements. At the same time, the CFTC will be reviewing the basis upon which non-us exchanges and non-us broker-dealers are able to access US customers under its no-action letters and Part 30 rules respectively. All of this points to the fact that global solutions and consensus may be progressively undermined by regional solutions, extraterritoriality and political populism. The consequences of these reforms are difficult to predict at this early stage, particularly insofar as the EU has not yet developed technical standards and, of course, the overarching legislation has yet to run the political gamut of the European Parliament, and what comes out of that tunnel may be rather different to what went in! While there is much to support in the EU programme for regulatory change, there will be consequences, some of which will give cause for concern. For example: 1. Potentially, 60 70% of contracts in most key OTC markets will be CCP cleared, changing the risk profile of CCPs and increasing their regulation leading to higher clearing fees and a safety first approach, which could result in higher and more frequent margin calls. 15

16 Focus Regulation Amore interventionist approach will result in regulators monitoring the judgements of senior managers, firms business models, remuneration structures, growth strategies and systems and controls for managing risk all of which will challenge the growth/risk ratios of regulated firms (and, potentially, the unregulated affiliates of banking groups). 3. The regulatory focus on governance and people risk will lead to higher business conduct standards, but also increased legal and regulatory individual risk. 4. Regulatory spill-over of banking regulation will mean that non-banks and specialist dealers will find making the case for differentiated regulatory treatment that much more difficult and banking regulation does not come cheap! 5. The post-crisis mood for extraterritoriality and regional solutions will generate more regulatory duplication and could restrict market access for non-domestic market infrastructures, banks and investment firms in what is still a difficult economic climate. 6. Tougher capital rules for dealers, higher clearing fees and closer business conduct rules will all generate increased business costs, the bulk of which will be passed on to customers and counterparties. Further, bilaterally cleared bespoke transactions will become more expensive (e.g. restrictions to loss-resistant collateral, higher prudential requirements, mandated margin calls), potentially to the point where the exemption for non-financial end-users from compulsory CCP clearing may not amount to very much. 7. End-users will face regulatory compression over choice, diversity, innovation, increased risk management costs and growing pressure to use standardised contracts to hedge tailored and often complex underlying risks, while mitigating credit risk, this could be offset by increased basis risk. Paradoxically, while one of the original regulatory objectives of MiFID was to enhance customer choice, it is likely that MiFID 2 will look to reduce choice. 8. The use of prudential rules to disincentivise proprietary trading, controls on financial trading essentially in commodity markets and increasing end-user costs could all generate reduced order-flow posing potential liquidity problems for some of the smaller and more specialist markets. 9. New safety first rules will challenge traditional business models and revenue streams and there will be tensions between capital efficient use of assets and safe-harbouring them for purposes of accessibility and risk mitigation. 10. Clearing houses (and increasingly their clearing members) will not wish to see undue exacerbation in their risk profile and, for this reason and reflecting the fact that they are the risk-takers, CCPs should have the last word on clearing what may be construed as otherwise eligible OTC contracts. As for the regulatory authorities, they will have to exercise restraint in driving forward their policy to see as many OTC contracts CCP-cleared as possible, if the risk to the system posed by CCPs is not to become unacceptably high. 11. Exchanges, particularly those clearing OTC products, will look to extend their execution and back-office services into the OTC space and regulatory policy will look to incentivise that kind of market transfer sothe dealer execution model will face both regulatory and competitive pressures. On the other hand, if regulatory concerns surrounding transparency, reporting and back-office processing of bilaterally-executed contracts (whether CCP-cleared or not) are resolved, the EU may yet take the view that there are no further risks of bilateral execution that would justify prohibiting end-user choice over their preferred execution methodology. With regard to the issue of regulatory arbitrage, the fact is that jurisdictional rules are never the same and there will be differences between the EU and the US. The question is whether those differences will be sufficient to justify the cost of business relocation. Certainly, there will be a significant degree of arbitrage between East and West and it is that prospect that may make regulatory consensus to any degree of granularity difficult to achieve on aglobal basis. Anthony Belchambers is a barrister and currently Chief Executive of the FOA. He is also Chair of MiFID Connect, a member of the Court of the Guild of International Bankers (GIB) and a cofounder, in their original forms, of both the Alternative Investment Management Association (AIMA) and the European Parliamentary Financial Services Forum (EPFSF). More generally, he is closely involved with HM Treasury and UK Trade &Investment in developing London s role as a global financial centre and is a regular member of the Lord Mayor s business parties on overseas missions.

17 Iharvest opportunity from risk. JOSÉ AROLDO GALLASSINI President, Coamo Agroindustrial Cooperative ForJoséAroldo Gallassini, turning risk into opportunity is second nature. As president of Brazil s largest agricultural cooperative, he comes to CME Group to mitigate price volatility and protect his organization s position in the global soybean market. With unparalleled liquidity, transparency and speed, and the security ofcentral counterparty clearing, CME Group guarantees the soundness of every trade. That s why CME Group is where the world comes to manage risk. Learn more atcmegroup.com. CME Group is atrademark of CME Group Inc.The Globe logo, CME, Chicago Mercantile Exchange, E-mini and Globex are trademarks ofchicago Mercantile Exchange Inc. CBOT and Chicago Board of Trade are trademarks of the Board of Trade of the City of Chicago. NYMEX, New York Mercantile Exchange and ClearPort are trademarks of New York Mercantile Exchange Inc. COMEX is a trademark of Commodity Exchange Inc.All other trademarks are the property oftheir respective owners. Copyright 2010 CME Group.All rights reserved.

18 Focus Regulation Segregation Does it Deliver What it Should? Segregation has had a mixed history in the European context. It has long been the basis for protection in the United States and in the United Kingdom (UK). While the legal foundations used in those jurisdictions have been robust, the practical impacts have differed. The European approach (including the United Kingdom) focuses on ring-fencing, but may not be what clients want or need. 18 In the aftermath of Lehmans failure, the protection of client money and assets has been the focus of attention as never before. Many funds, hedge funds and others, have found a significant portion of their assets caught up in the insolvency processes. All have claimed that they were (or should have been) protected and looked for the swift return of their money or securities. In the US open positions and the supporting collateral could be moved to another institution. In Europe this did not happen, and clients have had to wait alengthy period to retrieve what belongs to them. Segregation and MiFID In the European context the most useful starting point is the European Union s Markets in Financial Instruments Directive (MiFID directive 2004/39/EC). Article 13(7) and (8) require that investment firms, as organisational matters: when holding financial instruments belonging to clients, make adequate arrangements so as to safeguard clients ownership rights, especially in the event of the investment firm s insolvency, and to prevent the use of aclient s instruments on own account except with the client s express consent and when holding funds belonging to clients make adequate arrangements to safeguard the clients rights and, except in the case of credit institutions, prevent the use of client funds for its own account. These provisions are supplemented by additional detail as to the organisational arrangements expected from firms in Section 3 of the MiFID implementing directive (2006/73/EC). In essence these require good records and steps to be taken to have instruments held by custodians and money held at banks to be in accounts that differentiate, effectively, between afirm s own assets and those of its clients, and also that enable the firm to identify what it holds for each client. Systems and controls are also required to ensure that these are followed. On their face these requirements ought to be effective to protect money and assets in astraightforward broking relationship where the broker executes the deals and settles the sales/purchases on behalf of its clients. However, to be effective regulation needs a suitable backdrop in the property and insolvency laws of the jurisdictions where they operate. The UK s experience In many ways the MiFID approach is one that the UK has been familiar with for some time. The UK approaches the ring fencing requirement through the use of its trust laws (except in Scotland though a similar approach is taken), which have long been used to differentiate between assets held by aperson for another and those he owns himself. Indeed in the stockbroking context I have previously needed to review a number of Victorian cases in which the trust approach was found to be effective in protecting client money from the general creditors of abroker. The UK s experiences in the aftermath of Lehmans failure have not been happy. In the Lehmans case itself, there have been severe delays in returning assets and money to clients. The complexity of the approach adopted by Lehmans clearly did not help, but commentary on the case has been used to criticise the legal structure of the UK s client money and asset protection. The client money and assets held by Lehmans have been the subject of protracted argument in the English courts, in two principal strands. First, the administrators of Lehmans in the UK put forward ascheme of arrangement under the The[re was] no difficulty in affirming the effective segregation generated by the statutory trust. Companies Acts to try to conclude the client asset position more swiftly. However, the scope of such schemes is limited to acompany s own assets. The English courts therefore had little difficulty in affirming that assets held as custodian are not a company s own assets and thus not capable of forming the subject matter of a scheme. In truth, given the wording of the statutory provision in question, I am surprised that the administrators and their legal advisers thought that the contrary view could prevail. The second, and more important, strand related only to client money and involved detailed arguments about the FSA s implementation of the MiFID provisions outlined above. The court, as with assets, had no difficulty in affirming the principle of effective segregation generated by the statutory trust imposed by the FSA s rules. The difficulties related to the identification of what money was subject to the trust, and the identification of which clients had aclaim and how to value that claim. A good deal of the complication in the former resulted from the use by Lehmans of the alternative approach permitted by the FSA rules. The standard approach, generally speaking, requires money received from clients to be paid into segregated accounts, and then money properly due to the firm

19 Focus Regulation to be transferred out promptly. Under the alternative approach all money is received into non-segregated accounts and an appropriate amount kept in segregated accounts based on sums received. That meant that when Lehmans failed, clients money was not segregated. The English Court of Appeal decided, however, that even non-segregated money was to be brought into account (a more likely position when the alternative method has been used). In similar fashion the same court also decided that clients whose money had not in fact been segregated should benefit from ashare of the protected client money as well as those whose money had been segregated. To do otherwise would penalise those who had been least well served by Lehmans administration of client money, which cannot be fair. In truth, the practical failings at Lehmans (and shortcomings in regulatory supervision) were probably far more important causes of the shambles that followed its insolvency. In support of that view one needs to consider other regulatory actions taken by the UK s Financial Services Authority (FSA) against firms for failures to follow or implement internal procedures. The most high-profile of these is the fine of over 30 million imposed on JP Morgan Chase for not putting in place with banks the necessary documentation to ensure that the banks acknowledged the segregated status of the funds, over a period of several years. That requirement is a basic and fundamental part of establishing protection for clients but it simply was not done, and no one (including the auditors) noticed that it had not been done for several years. Banks are not charities and in an insolvency situation will certainly take advantage of such lapses to protect their position. Clearing houses, unless they accept (or are required to accept) that they have no right to set off clients collateral against a firm s proprietary positions, will do likewise. How might segregation be improved? In the context of derivatives dealing, the way in which the industry operates may not perfectly fit the way the regulatory requirements are framed (as with much of MiFID and other legislation). There is atension between the desire to protect the interests of the ultimate users of the financial markets (the consumers) against market and firm failures, and the protection of those markets against firm or customer failures. Not only is There is atension between the protect[ion] of consumers against market and firm failures, and the protection of those markets against firm or customer failures. this unresolved, in either policy or legislative terms, but the funding flows of derivative trades in the European context does not appear to be on the radar. In the United States the CFTC s approach is to facilitate continuation of trading, so that open positions can be moved if an individual broker fails. The model involves positions to be margined through the broking chain on a gross basis and accordingly, there is avery much larger amount of value backing open positions, and a greater ability to identify collateral to particular clients, compared with the European model. But, in the absence of achange in the ability of firms to use client collateral, it would probably entail a greater expense for clients because firms are likely to struggle to provide the kind of shortterm funding for clients that they do at present. The UK Government is currently consulting on a special insolvency regime for investment firms that hold client assets/money. The proposed regime would prioritise the return of client assets (including money), in part by making it a specific objective of the process and also by allowing administrators to impose a cut-off for claims to be made which would provide them with some certainty as to who the claimants are and the sums involved. But, it does not address all the issues. Requiring clients to make claims fails to recognise that it is the failed firm that should have the records needed (a regulatory requirement after all), and an obligation to take account of sums owed by clients to the firm and third parties simply reinforces the issue that commonly inhibits swift return of assets and precludes the transfer of positions for clients in the European framework. Perhaps a good start but more is needed to achieve what clients want and need. Richard Everett is a partner at Lawrence Graham LLP, and leads its financial regulatory practice. He advises a wide range of financial institutions, including derivatives brokers, making use of his 10 years experience at the FSA. One of his specialisms is the regulatory regime for client assets and money. 19

20 Review of the 31th SFOA Derivatives Conference ininterlaken Event The panel discussions at this year s meeting have been designed to take apractical look at the changes and challenges confronting the derivatives industry one year into the recovery from the varying perspectives of the industry players. Some of the highlights included during the first day the rise of high-frequency trading, during the next areview of the clearing world and the last anoverlook at hedge funds. 20 Wednesday, September 8, 2010 The unsettled weather that greeted the participants of the 31st Bürgenstock Meeting as they arrived at the Grand Hotel Victoria Jungfrau in Interlaken matched the mood in the industry as awhole. While things have improved over the past year there are still alot of question marks as to the near future. As SFOA Chairman Paul Meier pointed out while calling this year s meeting to order, the global economy does resemble a construction site after the global financial crisis. The globalized market place is still being regulated locally which makes good solutions difficult. A daunting task as the risk of regulatory arbitrage and its destabilizing result is a real threat. Old structures are crumbling, sovereign debt is growing, while saturated, over-extended consumers are striking and there seems to be little relief in site. Conferences like this one are necessary to allow discussions and networking and hopefully help prevent unwise decisions. The panel discussions at this year s meeting have been designed to take apractical look at the changes and challenges confronting the derivatives industry from the varying perspectives of the industry players. Keynote Speech Kicking off the pragmatic tone was the view from our host nation Switzerland, presented in the keynote address given by H.E. Ambassador Alexander Karrer, of the Swiss Federal Department of Finance in Berne. With its history as apioneer in derivatives markets, the tireless efforts of SFOA, and the I know, but that way would be better The lessons of the crisis must be learned, particularly in terms of crossborder cooperation. benefits of its position and location, Switzerland has punched above its weight since the birth of the derivatives industry. The Swiss economy has sailed relatively smoothly through the economic crisis, despite initial upsets, a temporary 1.9% drop in GDP and an increase in the accustomed low unemployment. With budget surpluses before the crisis hit and the right policy mix in response to it, Switzerland s financial sector has proven to be resilient. Following the severe economic crisis, which has seen the collapse of major companies, government bailouts, market downturns and ballooning sovereign debt, authorities around the world are preoccupied with regulatory issues to meet calls to reign in the derivative markets, particularly OTC trading. The lessons of the crisis must be learned, particularly in terms of cross-border cooperation. Ambassador Karrer sees three major changes resulting from the crisis. The IMF has grown in significance and become the lender of last resort for nations of all sizes. Its far-reaching reform has helped it rise to the occasion. The Financial Stability Board, established after the Asian financial crisis, was dusted off and given a broader mandate to make it the 4th pillar of global financial-market governance. It coordinates implementation of the international regulatory agenda. The third essential body meeting the crisis head on is the G20 as the main agenda setter for international bodies. It compiled 47 recommendations in an action plan aimed at fostering financial stability and market confidence. The Ambassador presented Switzerland as a microcosm in terms of the handling of issues that confront most nations and the financial industry as a whole. The private sector strives to provide high quality services for the economy, securing and enhancing market access through flexibility and adaptability. Systemically important companies seek to ensure high system stability and functionality, while authorities wrestle with the issue of companies that are too big to fail. Switzerland is holding such companies to ahigher standard of capitalization in answer to the risks they pose. The government supports the private sector with sound monetary and fiscal policy, maintaining an open and flexible labor market and instituting ahigh level of education. All this has the intended effect of preserving Switzerland s reputation for predictability and stability. Sharing common goals with the international community, Switzerland is ratcheting up international cooperation and working with international bodies to enhance stability,

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