By Joseph M. Gitto and Matthew T. Howes

July 21, 2015 marked the five-year anniversary of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) being signed into law. On that date, the International Swaps and Derivatives Association (“ISDA”) published a webinar in which CEO Scott O’Malia discussed some of Dodd-Frank’s successes as well as some of its challenges moving forward. On July 29, 2015, O’Malia also testified as to his findings before the U.S. House of Representatives Committee on Agriculture.

Title VII Progress

Initially commending the Commodity Futures Trading Commission (“CFTC”) and the Securities and Exchange Commission (“SEC”) on some of the rules promulgated thus far, O’Malia highlighted four areas in which Dodd-Frank regulators have made considerable progress:

• Clearing of standardized derivatives products;
• Trading of mandated derivative products on a regulated exchange or swap execution facility (SEF);
• Mandatory reporting of all swap transactions to a swap data repository (SDR); and
• Regulation of swap dealers (SDs) and major swap participants (MSPs)

O’Malia further explained that both U.S. and European regulators are close to issuing final rules for margin requirements, and that ISDA is looking ahead to the implementation of capital rules. Based on the Basel Committee on Banking Supervision’s framework, these reforms promise better quality capital, new liquidity requirements, and leverage ratios. While the reforms have a phase-in schedule to be completed by 2019, they have yet to be published at the national level.

Cross-Border Obstacles

Because the U.S. was first to roll out many of these regulations, O’Malia noted that it has been difficult to coordinate with other jurisdictions’ regulatory schemes. This has resulted in a significant impact on cross-border trading.

“Rather than being subject to multiple, potentially inconsistent requirements, derivatives users are increasingly choosing to trade with counterparties within their own jurisdictions,” O’Malia aptly observed, “the result is a fragmentation of liquidity along geographic lines.”

O’Malia called for more consistency of rules within and across borders. On issues such as SEF execution methods, U.S. regulators have taken a stricter stance than regulators in other G20 jurisdictions. “U.S. SEF rules should allow for greater flexibility in the execution methods in certain cases” he said. This would facilitate cross-border trading, alleviating the current trends of fractured markets and fractured liquidity.

Moving Forward: Harmonization

A common theme throughout the webinar and O’Malia’s House testimony was greater harmonization of regulations. Domestically, this means more consistency between SEC and CFTC rulemaking, especially as the two commissions finalize rules with respect to margin and capital. However, global consistency will be imperative as well.

Margin Requirements

While significant work has been done to promulgate the new margin rules, more time is needed for implementation. O’Malia reiterated the extension of the implementation date from December 2015 to September 2016, citing substantial changes in documentation, technology, and best practices.

In an effort to help streamline this process, last month ISDA launched its Standard Initial Margin Model (“SIMM”). This was described by O’Malia as a “common calculation engine for computing initial margin requirements for all market participants.”

Global harmonization of margin requirements will be important to U.S. firms moving forward. As an example, O’Malia mentioned a proposal from U.S. prudential regulators which would subject clearing-exempted transactions between affiliates of the same financial group to margin requirements. According to the CEO, this creates “something of a paradox,” in that such transactions face higher capital and margin requirements as a result of being exempted from clearing.

Capital Reforms

It is equally imperative that capital rules be globally consistent to prevent competitive advantages or disadvantages across borders. O’Malia would like the rules to be appropriate to the risk of the activity in question, and noted that “the interplay of the various regulatory components should be comprehensively assessed to ensure the cumulative impact is fully understood to avoid excessively high financing costs for borrowers and increased hedging costs for end users.”

One final area of focus for ISDA is pushing U.S. regulators to implement final registrations, as opposed to the provisional tags currently being applied. With a formal registration process in place, ISDA believes that SDs, MSPs, SEFs, and SDRs will all be able to move forward with confidence, putting an end to “regulatory doubt.”

Looking to the Future of Derivatives Markets

While some have focused on the pitfalls of Dodd-Frank in its first five years, ISDA maintains a cautious optimism for the implementation of margin and capital requirements and the harmonization of regulations within and across borders. In the coming months and years, such improvements to the regulatory landscape should alleviate the trend of illiquidity in derivatives markets, especially for cross-border trading.

O’Malia concluded, “At the end of the day, we want to make sure that these markets are viable, that people can continue to use them in a very transparent and open way, and prudently manage their risk.

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