Despite all of the accomplishments in making derivatives markets, safer, more robust and more efficient over the past 10 years, there’s one important area that still needs a lot of work: avoiding fragmentation of markets. That’s because the regulatory reform efforts have too often differed in scope, substance and timing across jurisdictions.
This matters because derivatives markets are global. The ability to trade across borders under a consistent and predictable regulatory framework is critical for derivatives users to hedge their risk, raise financing and invest efficiently. This is essential for sustainable economic growth.
Now, we recognize it’s not possible to eliminate all regulatory differences between jurisdictions. However, the current gap between global standards and national regulations can be large. This creates added cost, complexity and inefficiency for firms, and contributes to fragmentation. Ultimately, it increases risk for market participants and financial markets.
This is an issue Japan has highlighted as a key focus for its presidency of the Group of 20 (G-20). In support of that, we’ve published a paper that lists numerous examples of derivatives market fragmentation, cutting across clearing, trading, reporting, margin, capital, benchmark regulation and netting.
It also sets out a number of steps policy-makers could take to mitigate that market fragmentation. As a starting point, we need to do a better job of explaining why global markets are important and how they contribute to economic growth – here’s a video that makes a start on doing that.
Next, standard-setting bodies like the International Organization of Securities Commissions should play an active role in identifying those rules where inconsistences have emerged, and work to resolve those differences by achieving consensus across policy-makers. Greater harmonization in how the global regulatory framework is implemented will go a long way to reducing overlap and duplication and cutting excessive compliance costs.
Alongside these efforts, we need to ensure the process for making substituted compliance and equivalence determinations is more efficient. ISDA has proposed a risk-based framework for the evaluation and recognition of the comparability of derivatives regulatory regimes in foreign jurisdictions. We think this approach strikes a proper balance by focusing on risk and its cross-border implications, rather than attempting to align each and every regulatory requirement between jurisdictions. This will allow for outcomes-based decisions to be made, and will reduce the time it takes to make a determination.
We also recommend that international standard-setting bodies should establish a process that would enable national regulators to implement equivalency and substituted compliance determinations in a predictable, consistent and timely matter.
Regulatory tools do already exist to provide for substituted compliance and equivalence, and there has been some progress – notably, the agreement between the European Commission and the Commodity Futures Trading Commission to recognize each other’s trading regimes. But, in practice, decisions have been slow to arrive and are often made on a granular, rule-by-rule basis.
Central to all this, of course, is ensuring that the rules are actually appropriate. To this end, we recommend policy-makers regularly review reform initiatives to ensure they remain relevant and effectively achieve policy goals.
We welcome the fact that the Japanese presidency of the G-20 has highlighted this issue, and we stand ready to engage with regulators across the globe. Ten years on since the G-20 commitments, it’s time we tackled this last remaining issue once and for all.
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