The International Swaps and Derivatives Association, Inc. (ISDA) today announced that it has submitted a letter to the UK Financial Services Authority (FSA) regarding the Turner Review and accompanying Discussion Paper (DP 09/2), which outline a possible regulatory response to the global banking crisis.
“ISDA agrees with much of the analysis presented in the Review as to the causes of the financial crisis,” said Robert Pickel, executive director and chief executive officer, ISDA. “However, a stronger regulatory framework is just one aspect of the response to the crisis. The industry is making substantial and ongoing improvements in the key areas of the OTC derivatives infrastructure. These include the increased standardization of trading terms, improvements in the trade settlement process, greater clarity in the settlement of defaults, significant positive momentum toward central counterparty clearing, enhanced transparency, and a more open industry governance structure."
ISDA believes that while each of the Review’s regulatory proposals individually may have merit, there is little coverage in the Review or the DP as to the aggregate impact of adopting the proposed policies in combination. ISDA’s response also points out that in order to be truly effective, many of the proposed policy options require international agreement, such as higher capital requirements, definition and calibration of a leverage ratio, and supervisory arrangements. ISDA submits that the Review fails to apply sufficient weight to the importance of international accord on many of the proposals and that it is crucial that the regulatory consequences for the UK financial sector be considered in a broader context.
ISDA proposes that the FSA, in making its recommendations, should take into account the benefits of having a major financial sector, incorporating active trading markets, based in the UK. ISDA’s response also outlines the benefits of CDS trading activities and innovation in the financial markets, including providing essential risk management tools to help reduce the costs of doing business and warns against impairing this activity.
Also, while ISDA is supportive of certain capital reforms, including the Basel Committee’s focus on strengthening the trading book capital charge — provided that any resulting rise in capital requirements is reasonable and is introduced over an appropriate timeframe – it also points out that there are nonetheless categories of risk for which additional capital is not the most effective mitigant, and cautions against inappropriate application.
ISDA also observes that the Turner Review largely restricts its analysis of the role of collateral to that posted in OTC derivative contracts and that a more thorough analysis of the financial markets would uncover a widespread use of contractual provisions for collateral usage. The increase in margins and haircuts on a whole range of assets, not just OTC derivatives, contributed to procyclicality in the financial system. In this context, ISDA highlights that the Counterparty Risk Management Policy Group recommends a “paradigm shift in credit terms,” urging market participants to establish haircuts and initial margins that are stable over the credit cycle, a recommendation which ISDA supports.
ISDA’s complete response to the Turner Review is available at www.isda.org.
