A single word can be used to sum up 2022: unpredictability. From the war in Ukraine to the meltdown in the crypto sector, this year has seen a succession of unanticipated events that have shaken markets. Given the uncertainty of the past 12 months, it’s challenging to make predictions about 2023, but there are several key issues we think will continue to be a priority: the treatment of non-bank financial intermediation (NBFI), further improving transparency and the ongoing development of sustainable finance.
Regulators globally have been looking at the impact of NBFI on financial stability since the March 2020 ‘dash for cash’, amid concern that it has the potential to amplify shocks, creating wider price volatility and liquidity stresses and disrupting the ability of markets to function. Recent events like the sharp rise in UK gilt yields and subsequent intervention by the Bank of England in September have further underscored the importance of this issue.
In response, global regulators have begun a program of work to understand and address potential vulnerabilities in NBFI, covering the use of leverage, liquidity readiness, transparency and margining practices. We expect this topic to be a core focus in 2023. ISDA can potentially feed into this work in several areas in derivatives markets by providing analysis on margin models, collateral eligibility, stress testing and post-trade risk reduction, as well as developing industry solutions on collateral operations and regulatory reporting and transparency.
The latter issue has been a big focus for ISDA for some time, and we recently launched our Digital Regulatory Reporting (DRR) initiative to cover revisions to the US Commodity Futures Trading Commission’s (CFTC) swap data reporting rules, the first batch of which came into effect on December 5.
The DRR is intended to improve the accuracy and consistency of what is reported to regulators by giving firms access to a collective interpretation of the CFTC amendments developed by an industry working group. Using the Common Domain Model, this mutualized interpretation is available as human-readable and machine-executable code that firms can either use as the basis of their implementation or to check their own understanding of the rules is in line with the industry consensus.
Other regulators are set to follow the CFTC’s lead, meaning this will remain a key priority in 2023 and 2024. ISDA is working to extend the DRR in response, increasing the efficiency of implementation and ensuring regulators are better able to monitor potential sources of risk.
Another area of focus in 2023 will be the continuing development of sustainable finance. Following the recent COP 27 climate summit, there is growing recognition that efforts to eliminate greenhouse gas emissions need to accelerate, but this will require an estimated $110 trillion in capital by 2050 to fund the necessary sustainability projects, technology and infrastructure.
ISDA has focused on supporting the transition by developing robust legal and risk management standards to ensure markets linked to environmental, social and governance (ESG) function safely and efficiently. For example, we’ve published several papers exploring the key legal and regulatory issues relating to the voluntary carbon market and we recently launched the 2022 ISDA Verified Carbon Credit Transactions Definitions, together with template confirmations for spot, forward and options contracts.
In addition, we have published several whitepapers to support the development of standards for sustainability-linked derivatives (SLDs). We’re now exploring whether to draft standardized terms for documenting SLDs, which will bring greater harmonization and efficiency to this nascent product. We’re also looking closely at the capital treatment of carbon credits and progress by banks to develop scenario analysis to assess the impact of climate risk on their trading books.
These are just three of the many topics that will likely dominate in 2023, but there are plenty of others. In the digital assets space, for instance, we remain committed to developing definitions for certain over-the-counter crypto derivatives, as well as work on netting, collateral and bankruptcy protections. While the issues may change year to year, ISDA’s focus will be the same as it’s always been – to develop the legal documentation, standards and mutualized solutions needed for derivatives markets to function safely and efficiently.
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