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ISDA's Julian Day, Head of Market Infrastructure, discusses the top operational priorities for 2012 and explains how ISDA aims to help market participants address concerns regarding central clearing of OTC derivatives, implement the new standardised CSAs and the 2011 equity derivatives definitions.
Q. What will be the main focus for ISDA in 2012 from an operational point of view?
2012 is going to be very much the year of transition in that we move from the current environment where the agenda is almost exclusively set by the terms of the Fed letters, which set up an ambitious agenda of quasi voluntary tasks to improve the market infrastructure, to a world where we are complying with hard and fast legislation and new rules set out by the Dodd-Frank Wall Street Reform & Consumer Protection Act (Dodd-Frank), the European Markets and Infrastructure Regulation (EMIR) and regulation that we expect to follow in other regions including Asia Pacific.
Despite the massive effort and resources required to focus on central clearing, transparency and standardisation, the ‘business as usual’ projects which ISDA is primarily known for, such as the publication and maintenance of definitions and the confirmation process, is still ongoing. It will be a challenge for me personally and for ISDA to balance these ongoing initiatives with the larger market infrastructure changes coming with new regulation.
Q. What are some of the specific ISDA initiatives that will be main priorities in 2012?
There is a whole raft of technical tasks but the major one, and certainly the item that is front and centre of my view next year, is the implementation of the 2011 ISDA Equity Derivatives definitions. This is significant because we are looking to change the whole business model of the equity derivatives definitions. Specifically, we aim to implement equity derivatives definitions into a matrix format - a format that is currently used for vanilla credit derivatives. These definitions will also be hosted in electronic format enabling ISDA to update the definitions more frequently than the six to eight year cycle typical for the republication of the book of definitions. Equity derivatives are a very diverse and complex asset class in terms of participants, underlyings, and product types, which is why electronic confirmation and processing levels are that much lower than other asset classes. So, moving to this electronic format under the new definitions will enable more electronic processing as well as reporting around what options market participants are using or not using.
There is also a project on foot to introduce some standardisation around the Credit Support Annex (CSA). This project, which I believe will conclude in 2012, is an initiative that plays into the standardisation theme and therefore will be welcomed by regulators.
Q. Central clearing - how does ISDA aim to address concerns in the moving of some OTC derivatives to a central cleared environment?
The most significant initiative we are focused on with regards to clearing is the establishment of the Industry Clearing Committee (ICC), which we set up in [Q4] of 2011. In essence, this new committee was formed to look at the clearing concept, to identify obstacles at all levels of clearing, address those issues and hopefully overcome them.
Currently, there isn't a discipline within ISDA that is not affected in some way or another by clearing so what we want to do is bring all of those issues together. And yes it's another committee for us to administer, but the idea is that it will be a place for the industry across the board to come together and propose plans to deliver against clearing commitments. Today, ISDA has various product steering committees and the operations steering committee, which are all relevant, but we are seeking to extract the clearing element from those committees and centralise it into one single place. It's an ambitious body of work that the ICC committee has to manage in terms of the operational, product, legal and risk management aspects of clearing.
As for membership, the ICC is a broad-based committee comprised of buy-side, sell-side and clearinghouse participants. We also have other trade associations represented in the committee so the group is comprehensively representative of the market as a whole.
It is early days for the group, which has met a few times already, but I think the committee is going to be a focal point for the industry and for ISDA during the course of next year. There is going to be a whole schedule of work to come out of that.
Q. Collateral Management - What are the priorities for collateral management?
The focus for 2012 is a mixture of ongoing ISDA projects including dispute resolution, portfolio reconciliation and electronic messaging for collateral calls.
Dispute resolution is still not conclusively resolved in terms of the approach of the more intractable disputes so there is still ongoing effort to support this activity. However, the dispute resolution project may slacken somewhat as the rules from the US Commodity Futures Trading Commission (CFTC) come out because the rules may support or oppose the approach proposed so far.
With portfolio reconciliation the aim is to extend the reach and penetration into smaller portfolios and set out the frequency and other minimum market standards surrounding this process.
2012 is also going to be a big year for electronic messaging for margin calls. Today collateral messaging is very manual and much like what confirmations used to be 10 years ago. Electronic messaging is a developing space and there are a couple of different vendors out there now, so I think we are going to see the reach of that initiative extend into 2012.
Another significant project for collateral management will be the working brief on segregation of initial margin. This is something we have published a lot of documents on recently to provide a means by which counterparties can easily and in a straightforward manner provide segregation. Naturally, collateral segregation is an issue that came out of the MF Global default and the focus remains on this topic and other potential impacts will become clear in time.
By far the biggest project for collateral next year will be the conclusion of the standard CSA documentation and implementation as mentioned previously.
Q. What are some of the other operational challenges you see operational professionals facing in 2012?
Location strategies are under review and will be impacted by the market change. I've been doing quite a lot of work with firms who have huge presences in other global locations, such as India and this represents a huge shift in the back office and operations function in the industry for all locations. So, location strategy is a concern but also fighting for IT budgets and headcount in a climate like this isn’t easy.
We will be seeing financial institutions more closely integrate their exchange-traded derivatives operational teams, who know clearing well from the futures part of the business, with the OTC derivatives staff. Historically, these two departments have been completely separate - different buildings and even different legal vehicles. But now, because of the clearing imperatives, you're seeing a coming-together of those business units and operations, so many banks face the challenge of resource allocation to meet the new integrated operations.
More generally, the transitionary nature of the industry is 2012 and the lack of certainty of the rules will be the primary challenge for derivatives operations professionals. Operational professionals are very good at implementing things in the way they are required to do, but they need clarity at the beginning of the year on the regulatory rules and what needs to be put in place in terms of market infrastructure change, trading via swap execution facilities (SEFs) to centrally clear via central counterparty clearing (CCP). For instance, over half of the interest rates market has been cleared for a number of years so this isn’t a new concept however, to get to the point where the industry can bring on new projects and participants whilst also maintaining the bilateral operations, is a challenge. And I think as an industry we are meeting those challenges quite well at the moment, but there will be many more to come next year.
Julian Day is Head of ISDA’s Market Infrastructure team, and is based in ISDA’s London office. The team covers ISDA’s work in the fields of Operations, collateral management and market practice.
Prior to rejoining ISDA to take up this role in July 2008 after a period with RBS, he originally joined ISDA in summer 2003. Formerly Mr. Day was a Director with Credit Suisse, where he performed senior roles in Operations and Compliance. Since entering the derivatives industry in 1990, Mr. Day has held a number of management roles in Operations and Legal Departments.
Mr. Day graduated in Law in 1986.