The pace of financial regulation is quickening and a new colossus, in the form of the G20, is pushing for more. The onslaught of new rules, covering everything from capital requirements to trade reporting and operations – via Basel III, Dodd-Frank, AIFMD (see ‘Acronyms Alphabet App’, right) and others – is already hitting the industry.

The over-the-counter (OTC) trade reporting rules under EMIR went live on 12 February 2014, creating a deluge of new information for regulators and a huge workload for practitioners in firms big and small. That rule on its own has led to a gold rush for consultants – the “gift that just keeps on giving,” quips Dr Andrew Hilton of the Centre for the Study of Financial Innovation, which has made a special examination of the post-trade landscape.


G20 and global policy
Now, G20, the rich countries’ club, plans to use its prime ministerial and presidential muscle to wade into the melee. Tony Abbott, Prime Minister of Australia, which holds the presidency of G20 this year, says: “G20 members have made considerable headway in global financial reforms aimed at preventing a repeat of the global financial crisis. But this work remains unfinished. To promote a more resilient financial system, as G20 President, Australia will make it a priority to complete financial reforms in four core areas directly related to the causes of the crisis: building the resilience of banks; helping to prevent and manage the failure of globally important financial institutions; making derivatives markets safer; and improving oversight of the shadow banking sector.”

At its 2013 summit in St Petersburg, G20 made almost as many financial regulation recommendations as it had done in the previous five years – and there is much more in the pipeline from the Australians and next year’s President, Turkey. Despite lacking any formal ability to enforce rules, the G20’s prominent membership gives it a strong influence on global policy.

The 2008 financial crisis highlighted shortcomings, such as a dearth of counterparty risk management and a lack of transparency in the OTC derivatives market – particularly in the default of Lehman Brothers and the near-collapse of

Bear Stearns in 2008. At their meeting in Pittsburgh the year after the crisis, the G20 countries passed a resolution stating: “All OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest. OTC derivative contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements.”

EMIR, the European Commission’s flagship derivatives project, was designed to reduce counterparty risk in OTC markets and to increase transparency. While a  sound idea in principle, many think that the regulation is ill thought through, and the deadlines ferocious. Old hands knew well before the launch that midweek – yes, a Wednesday – was no time to switch on a major financial IT project.

EMIR covers three areas in this field: clearing, reporting, and margin and capital.

The clearing requirement applies to financial counterparties (including banks, insurers and asset managers) and to non-financial counterparties. Intra-group transactions are exempt, and pension funds have a three-year grace period. The counterparty has to be a clearing member, a client of a clearing member (direct client) or a client of a client,

with indirect clearing arrangements. This choice for most firms has rested on the best balance between the protection of a full omnibus-account model or individual segregation, and operational efficiency. Daily reporting to the competent authority – ESMA in Europe and then to national regulators – is now required for all OTC trades to identify potential systemic risks. But can ESMA, with fewer than 200 staff, make sense of the frightening amount of data now pouring into its systems every day, from the market players and the new European trade repositories set up to handle the work?

“Try taking a sip from a fire hydrant,” warns one insider.


The US position
Over the pond, the Federal Reserve Board and other financial regulators issued a final rule on 10 December 2013 implementing section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act – the

‘Volcker Rule’. This prohibits insured depository institutions and their affiliates from proprietary trading and from owning and sponsoring hedge funds or private equity funds. Certain activities such as market-making, risk-mitigating hedging,

and trading in some government securities are excluded from the rule, and banks can still act as agents, brokers or custodians. Volcker requires banks to establish internal compliance programmes, the detail depending on the firm’s size and scope.

Banks with larger trading operations will face the most detailed requirements, including a written statement from their CEOs attesting that the programme is “reasonably designed to achieve compliance with the final rule”.

Can ESMA, with fewer than 200 staff, make sense of the frightening amount of data?

Fed Governor Daniel Tarullo, head of the Board’s bank supervision and regulation committee, sees a key challenge in defining the line between proprietary trading and marketmaking and hedging. “The difficulty in doing so inheres in the fact that a specific trade may be either permissible or impermissible depending on the context and circumstances within which that trade is made,” he explains.

The Fed requires banks to be fully compliant with the Volcker Rule by July next year.

Brussels’ roleAt the end of January 2014, the European Commission unveiled its own version of Volcker. The reforms affect about 30

huge firms – globally systemic banks, and institutions where total assets for three consecutive years exceed €30bn and whose trading book is more than €70bn or 10% of its total assets. Though a step back from the 2012 Liikanen Report, which would have split lending operations from trading in the big universal banks, Michel Barnier, nearing the end of his rule as EU commissioner in charge of financial services, views them as the climax of his reforms since taking the reins in 2010. But like their American  cousins, the new rules won’t hit the street until December 2015 at the earliest – giving worried observers (say, G20) time to put their oars into these already turbulent waters.

Under this final Barnier edict, supervisors would be empowered to force activities such as market-making and trading derivatives into separately capitalised entities. The potential inclusion of market-making is a rich source of argument between European capitals; it goes far beyond what the French and Germans, for instance, have in mind – and Brussels. And the consultants can barely contain themselves.

George Littlejohn MCSI is a Senior Adviser at the CISI

Acronyms Alphabet