As part of the regulatory response to the financial crisis, there has been a major focus on markets and traded products, including the Derivatives contracts used by financial institution or end-user companies to hedge their credit, interest rate and foreign exchange risks.
Key components of this include greater use of Central Counterparties (CCPs) to clear trades, mandated use of Trade Repositories (to create greater transparency and visibility of positions in the market), and the levels of initial margins. The CCPs in turn have their own requirements in terms of the types of collateral (and currencies) that they will accept.
Markets and traded products are also impacted by the Bank Prudential Regulation, including the capital treatment of market risk and counterparty credit risk, liquidity requirements, and the Basel Committee’s current Fundamental Review of the Trading Book (FRTB).
Beyond compliance requirements and the adoption of new market infrastructure and practices, these changes have far-reaching impacts for transactions, both in the capital held, and also in the funding and liquidity required to support them.
Whilst there are many variables, and specific impacts will differ by bank, counterparty, product-type and jurisdiction, in general there is a greater sensitivity for transactions that have a long-dated tenor and/or involve a principle exchange (eg. cross-currency swaps). This may ultimately affect the cost and availability of some hedging products.
The IIF has been active in arguing for alternative approaches to mandatory initial margin, particularly on cross-currency swaps, and have successfully made the case for modifications to the regulation.
On CCP crisis management, we have been building on our extensive work on bank recovery and resolution, seeking to ensure that the approach taken reflects the special role and structure of CCPs, recognizing the varying roles of direct and indirect participants, risk governance, and default mechanisms.
Since the FSB outlined who should be regulated as Derivatives Market Intermediaries (DMIs) in June 2012, they have subsequently proposed standards for margin requirements and data collection, among others.
The Basel Committee released its final standard on bank capital requirements for CCP exposures in April, following a Consultative Document published in June 2013 and a QIS, and they have intended for this to complement the CPSS-IOSCO Principles for financial markets infrastructures.
Developments in Market Risk capital requirements and the FRTB are running concurrently, but as a separate line of activity.