The Securities Industry and Financial Markets Association (SIFMA) monitors and responds to new global regulatory proposals. In a Q&A with Kyle Brandon, SIFMA’s managing director, head of Derivatives Policy and Bill Thum, managing director and associate general counsel within SIFMA’s Asset Management Group (SIFMA AMG), we explore the possible changes afoot in the derivatives clearing space and swaps dealer regulation space in 2023.
Q: What do you believe will be the overarching changes in the derivatives clearing space in the USA in 2023 and why?
Bill: 2023 will see a range of rule proposals to enhance aspects of cleared markets, particularly within the Commodities Futures Trading Commission (CFTC). These rule proposals spring form the work of the CFTC’s Market Risk Advisory Committee (MRAC) subcommittee on CCP risk, which met between 2019-2020 and culminated in four reports addressing capital, stress testing and liquidity, margin methodologies and governance.
The CFTC and the Securities Exchange Commission (SEC) have already put out rule proposals to address opportunities to enhance governance with respect to clearinghouses. The International Organization of Securities Commissions (IOSCO) has also put out consultations addressing margin practices, clearinghouse access and portability, and non-default loss issues.
These issues are being addressed because of a perception of need by the regulators, and as they move to increase the clearing mandates, a recognition that the infrastructure for clearing needs to be as robust as possible. The market has been calling for this for many years and the buy and sell sides are fully aligned on the need for improvements. Through trade associations and working groups, industry participants have been advocating for various enhancements. These suggested enhancements gained the attention of regulators, and those issues are gaining traction now in 2023.
Q: Can you shed light on the significance and the impact of the proposed amendments to enhance Derivatives Clearing Organizations’ (DCO) governance standards?
Bill: The issue of governance is very important in a clearing mandated market, as how decisions are made by the clearinghouses’ risk committees can affect the quality of the decisions. For instance, to what extent are risk committees required to engage with market participants and consider their feedback, or share such feedback with the clearinghouse’s leadership? And to what extent are agencies aware of any conflicting feedback from market participants as they consider CCP rulebook changes and new product offerings?
The CFTC and SEC’s proposed amendments to enhance DCO governance standards call for the inclusion of all market participants, particularly the buy side, in the governance process. Especially as certain risks are mutualized across clearing members, and shared with market participants generally, the perspective of buy-side experts can serve to balance consideration of the products offered, assessment of such products’ risk parameters, and whether margin methodologies are appropriate for those products. Making sure that information is shared from the clearinghouse to market participants, and that the views of market participants are considered, will strengthen the ultimate resiliency of the cleared derivatives space.
SIFMA’s members have fully embraced central clearing of derivatives. These amendments offer an opportunity to take stock of existing governance practices and ensure that for product and risk decisions there is a diverse set of views being considered by the clearinghouse and by the agencies. Market participants support innovation in the market and the opportunity to clear more products. The goal is to make sure a product has enough standardisation and liquidity for the risk to be well understood, margin levels to be appropriately set, and risk to be adequately managed by the clearinghouse.
One concern, for instance, revolves around the introduction of new products. The scenario is that if a product is brought into the cleared space and then shares in the same default fund of other products, this new product introduces risk to market participants that may not even clear those newly added products. In short, if there is a new product with a narrow band of users, the way the risk is currently socialised within the default fund, risk introduced by that narrow band of users is effectively shared and socialised across the market.
Clearinghouses need to ensure their risk committees consider a broad range of perspectives that include not just clearing members but also enable asset managers to advocate for the best outcomes for their investors.
“Making sure that information is shared from the clearinghouse to market participants, and that the views of market participants are considered in product and risk decisions, will enhance the ultimate resiliency of the cleared space,”
– Bill Thum
Q: What is the significance of the Japan Financial Services Agency’s (JFSA) application for a Capital Comparability Determination?
Kyle: This is a swap-dealer regulatory issue that has knock-on effects to everything else. Derivatives trading is a global market with players all over the world and there is almost no trading that does not have a cross-border aspect. Post-financial crisis market regulation has sought greater harmonisation and coordination between global regulators. G20 countries are major markets that now universally subscribe to the BCBS IOSCO capital requirements or something very similar.
In the US, there are different capital regimes depending on the type of entity—whether it’s a bank, a non-bank broker-dealer or stand-alone swap dealer, for example. In each case, there may be somewhat different capital requirements and regulators of capital requirements. Of the 100-plus registered swap members, more than half are non-US entities. Most of the non-US entities are banks and therefore not subject to CFTC capital regulation. The remaining non-bank swap dealers registered outside the US are subject to CFTC capital regulation in addition to their home country capital regulation.
CFTC capital rules went into effect in late 2021, and the CFTC has been working with the four jurisdictions with applications for capital substituted compliance – Japan, Mexico, the EU and UK. SIFMA has worked with members in all four jurisdictions on the applications. There is also an open proposal for Mexico, which we are reviewing with members. The CFTC has taken great pains to understand the requirements in other jurisdictions. Their proposed orders reflect a real understanding and appreciation for the robustness of rules in other jurisdictions and the fact that they don’t need to be identical or go after risk in the same way to achieve the same regulatory outcomes. SIFMA submitted comments supporting the proposed order for Japan, including comments that are relevant for the three other applications.
Q: How do you expect to see this space evolve in 2023?
Bill: I expect the CFTC and the SEC to pursue the recommendations coming out of the MRAC subcommittee on CCP risk. SIFMA will continue to engage with the CFTC and SEC on these issues. We all share the same objective, to make sure the US and global capital and derivatives markets are robust, because they provide real benefits for the US and global economy.
As we transition fully through clearing and exchange trading, reporting, and introduce new products to the mix, it is important that the agencies make sure that the infrastructure for mandated clearing is as robust as possible. I see the CFTC continuing to turn its attention in those directions and building on the work that came out of the MRAC subcommittee across the dimensions of capital, skin in the game, margin methodologies, stress testing and liquidity. Those are the recommendations they still need to address.
“The SEC has an ambitious agenda with many rulemaking proposals, including some swap or security-based swap (SBS) specific rules such as SBS large position reporting and anti-fraud proposals. The SEC reg-flex agenda has these rules, along with many others, slated for the first half of the year, and it will be a huge piece of work to comply so many rules at once.”
– Kyle Brandon
Kyle: There are two swap dealer-related areas I am keeping my eye on that are on the reg-flex agenda. One is a longstanding dialogue we’ve had about risk management for swap dealers. The rules went into effect years ago and there have been discussions about how they might be enhanced or clarified so they work better with the ecosystem they are placed into. Swap dealers are bank, non-banks, or broker-dealers, and risk management should be holistic. They have also been talking about enhancing system safeguards in the cyber realm. SIFMA is very active and leads a host of work streams on this throughout the US regulatory system and internationally and looks forward to continuing the dialogue on these critical issues.
The SEC has an ambitious agenda with many rulemaking proposals, including some swap, or more specifically security-based swap (SBS) related rules such as SBS large position reporting and anti-fraud proposals. SIFMA and many market participants have commented on these far-reaching proposals. The reg-flex agenda has these rules, along with many others, slated for the first half of the year, and it will be a huge piece of work to comply with so many rules at once.
In addition to those SBS-specific rules, there are many other rules the SEC proposed that may have impacts on SBS, because SBS are defined as securities under Dodd-Frank. Any securities rule (for example a rule aimed at shortening the settlement cycle) must be evaluated from the SBS perspective. There are also proposed rules on short sale disclosures, securities lending disclosures, beneficial owner disclosures. All types of disclosures for position reporting rely on similar related systems, and we encourage the SEC to take a more holistic look at the impact such rules have in the aggregate.
Bill: We appreciate the focus of the SEC’s efforts and recognise the intent is to make the markets more resilient and transparent and protect the interests of investors. In our comment letters, we try to understand the issue that the SEC is targeting and evaluate the proposal to see if there are aspects of the proposal to better address and target the issue without either unintended consequences or excessive cost.
The Fine Print
- 87 FR 49559 – Proposed amendments to Regulation 39.24 that enhance the Commission’s DCO governance standards and are consistent with recommendations from the Central Counterparty Risk and Governance Subcommittee of the Market Risk Advisory Committee. More info
- 87 FR 48118 – Notice of Proposed Order and Request for Comment on an Application for a Capital Comparability Determination from the Financial Services Agency of Japan following an application submitted by the Japan Financial Services Agency (JFSA). Comments requested. More info
Kyle Brandon, Managing Director, Head of Derivatives Policy at SIFMA.
Bill Thum, Managing Director and Associate General Counsel within SIFMA’s Asset Management Group (SIFMA AMG)
