Response by Finansinspektionen and Sveriges Riksbank to the Consultation by the European Commission on Possible initiatives to enhance the resilience of OTC Deriva-tives Markets
Finansinspektionen
P.O. Box 7821
SE-103 97 Stockholm
[Brunnsgatan 3]
Tel +46 8 787 80 00
Fax +46 8 24 13 35
finansinspektionen@fi.se
www.fi.se
Financial Stability Department
SVERIGES RIKSBANK
SE-103 37 Stockholm
(Brunkebergstorg 11)
Tel +46 8 787 00 00
Fax +46 8 21 05 31
registratorn@riksbank.se
www.riksbank.se
Dnr: 2009-688-AFS
European Commission
MARKT-G2-consultations@ec.europa.eu
Sveriges Riksbank and Finansinspektionen welcome the opportunity to comment on the consultation document: Possible initiatives to enhance the resilience of OTC Derivatives Markets. We share the view that maintaining sound derivatives markets is essential for financial stability and that CCP clearing of many OTC derivative products can contribute to this. This response emphasises some general principles which should underpin derivative market initiatives and then discusses some of the issues raised in the consultation.
Consistent reasonable regulation is vital for sound markets. However, we would like to stress that regulation of derivative markets can only be a complement to stringent and comprehensive risk management at individual financial institutions. Non-financial corporations need tailor-made derivatives to manage their financial risks. Such contracts by nature cannot be fully standardised so sound risk management at the level of individual financial institutions is essential. Financial firms will always need to clear products bilaterally either because they provide products which are not eligible for CCP clearing or because CCP clearing does not fit in their overall risk management. This bilateral clearing entails counterparty risks and liquidity risks which must be managed. It is important that the regulation of these risks gives firms the proper incentive to manage risk effectively and to choose central counterparty clearing when it is appropriate. Good regulation of derivative markets would contribute to avoiding the problems experienced in the current financial crisis but sound risk management at individual institutions is also crucial to avoid the next crisis.
Future work on the initiatives for OTC derivatives markets should be based on three principles. The first is that regulation must acknowledge the global nature of derivatives markets. Authorities must reach harmonised regulation and minimise the burden on firms which are globally active. Otherwise Europe risks exporting business and importing risks from abroad. The second is to maintain the principle that individual institutions and central counterparties are responsible for managing their own risks. CCPs must be able to determine which instruments they can accept based on their capacities and risk management. Financial institutions must be able to judge when a central counterparty reduces their risks as they are best placed to judge their overall risk management needs. The third is that markets must remain flexible so that they can continue to meet the needs of end users. Companies and institutions use tailor-made OTC derivatives to manage financial risks which arise in their business. Regulation must allow for these special products. Guided by these main principles we would like to comment on a few of the specific issues addressed in the consultation.
Standardisation
The consultation document differentiates between two types of standardisation: contract parameters and contracts themselves. We believe that there is a third type of standardisation: technical standardisation which covers technical solutions for communications and management of these products. Market participants can achieve much of this technical and operational standardisation even for tailor-made products. Automatisation and standardisation of processes reduces operational risk and should be sought to the greatest extent possible even for non-standard contracts. In particular, it is unacceptable that the new clearing solutions, information systems and operational routines which are now being defined for derivatives markets do not achieve technical interoperability both within Europe and globally.
CCP-clearing
CCP clearing can provide sound risk management together with operational efficiencies. European authorities should encourage the establishment and use of such CCPs by providing clear, harmonised and consistent regulation of CCPs in Europe, providing a legal framework which allows them to work with certainty and by adopting counterparty risk management regulation which fully acknowledges the management of operational, counterparty and liquidity risks provided by CCPs. While CCPs should be well regulated, authorities should not promote CCP use in a way which diminishes each institution’s responsibility to investigate the risk which it runs in using the CCP and determine that the CCP provides a net risk reduction.
Regulatory capital incentives
The consultation asks if non-standardised OTC-derivative contracts should face a higher capital charge for operational risk to encourage standardisation and if an additional capital incentive in addition to the zero risk weighting should be used to encourage CCP-clearing. Special additions to capital charges should not be instituted. Capital regulation should be transparent and clearly linked to the risks which an institution takes. It should not be lightly adapted to current regulatory problems. Instead, the underlying regulation of operational risk management or counterparty risk management at individual financial institutions should capture the institution’s risk. Thus, an institution which does not use a central counterparty but does manage its risks to an equivalent degree would not face higher capital charges. In this case, if counterparty risk management regulation yields the same risk reduction as a CCP, it should receive the same charge.
Transparency requirements and public trading venues
We share the view that competition between different trading venues (OTC, exchanges and MTFs) is advantageous. However, we do not believe that pre- and post trade transparency regulation should be the same for all venues. Such strict regulation of transparency can reduce liquidity in markets as participants may be unwilling to reveal their positions by entering large deals. Instead, market venues should be able to compete as to the degree of transparency which they offer. Requirements for information to regulators should, however, be the same regardless of trading venue.
Position reporting to competent authorities
The consultation document discusses in a very general way the potential benefits of introducing a regular periodic position reporting obligation to competent authorities without more closely defining the concept of a position. The analysis seemingly disregards the fact that most transactions in derivatives are made to hedge exposures against clients or in the institution’s own book. For stability purposes a reporting of derivatives positions in isolation will thus be of minor value for a comprehensive analysis of the overall risk picture for a firm if not supplemented with information about off-setting exposures such as spot positions in order to reach an understanding of the firm’s net positions.
We are of the view that this very preliminary proposal requires further elaboration and a careful cost-benefit analysis. This should be done before the project is taken further. Without such an analysis we see the risk that this proposal builds up a European reporting scheme which is extensive, non-harmonised and costly both for regulators and the industry. Clearly, such a scheme would have little value.
FINANSINSPEKTIONEN SVERIGES RIKSBANK
Linda Hedval l Mattias Persson
Head of Department Head of Department
