We’ve all heard the saying, “Work smarter, not harder.” Nearly a decade since the financial crisis, we are finally getting a chance to put this adage into practice. In May, FIA published our response to President Trump’s call to review U.S. financial reform rules in the form of a whitepaper outlining specific policy recommendations for improving the U.S. regulatory framework.
Our recommendations are based on three general principles that we believe are widely applicable to markets worldwide. First, we support smarter regulation in which rules are tailored to the risk of the activity posed with the goal of keeping markets safe without stifling growth. Second, we support fair and open access to global markets so that liquidity can flow to where it is most needed and end-users have the widest possible range of options for their needs. Lastly, we support regulations that strike an appropriate balance between protecting market integrity and promoting responsible innovation and fair competition that allows the marketplace to grow and thrive.
First and foremost among our recommendations is to revise the leverage ratio so that it no longer penalizes central clearing. Our paper urges U.S. regulators to ensure that any revised Basel Committee standard on the leverage ratio includes an offset for client initial margin arising from the clearing of derivative transactions. Without this offset, the capital required by the leverage ratio undermines the economic incentives for client clearing and endangers the ability to port clients in the event of a clearing member default.
I’m pleased that more and more policymakers are publicly expressing support for our view on this issue. In April, at an FIA-sponsored event in Washington, Federal Reserve Governor Jerome Powell discussed the unintended consequences of including initial margin in the leverage ratio. “Take central clearing for clients," said Powell. "This is something we want and we think makes the world a better place, but we apply the leverage ratio to the initial margin posted by clients which makes it more expensive. We see clients getting out of the client clearing business, so we are undermining the clearing mandate.” This is a welcome comment and we hope other prudential regulators are coming to the same conclusion.
Our paper also recommends improved access for end-users to risk transfer markets. Since the financial crisis, certain elements of the regulatory framework have had the unintended effect of discouraging end-users from using derivatives and restricting their access to derivatives markets. We are pleased to see that the CFTC has begun to reassess its rules with an eye to minimizing this effect, but we believe that more can be done. For example, we ask that the position limit rule be withdrawn and re-proposed to ensure that legitimate hedging activities are not unduly restricted. We also ask the CFTC to provide greater certainty around the de minimis threshold for swap dealer registration to avoid harming liquidity in the commodity derivatives markets.
We also urge a re-tooling of reporting requirements. Post financial crisis, regulators have patched together existing reporting obligations with new reporting requirements. Regulators also have used tools such as “special call” requests to convert ad hoc information requests into on-going reporting obligations. It is time to consider holistically whether the reporting requirements meet the intended regulatory purposes, ensure that the information being collected is useful, and avoid duplicative or unnecessary collection of data.
"First and foremost among our recommendations is to revise the leverage ratio so that it no longer penalizes central clearing."
Walt Lukken
FIA
Meanwhile in Europe I am pleased to see that a similar regulatory review process is already producing results. In early May the European Commission issued a proposal to amend several important provisions in the European Market Infrastructure Regulation. EMIR established the framework for several core elements of the post-crisis financial reforms, including mandatory clearing and trade reporting. It has been in effect for several years, and I commend the Commission for taking stock of the implementation and undertaking a consultation process with the industry to identify areas where EMIR can be improved.
The Commission has now taken the next step, issuing a proposal to amend EMIR in line with the suggestions that it has received. I am especially pleased that the Commission's proposal includes several amendments that are particularly important to our members. The streamlined reporting requirements for exchange-traded futures and options will be a tremendous boon for end-users in our markets. The requirement that clearinghouses provide more transparency into their initial margin calculations will also be very helpful for clearing members. And the whole industry will welcome the Commission's commitment to amend the leverage ratio so that cash collateral posted by clients will be an offset in the exposure calculation.
Last but far from least, we welcome the announcement of Project KISS, Acting Chairman Chris Giancarlo's initiative to simplify CFTC rules to identify those areas that can be simplified to make them less burdensome, less costly and less of a drag on the U.S. economy. Giancarlo announced this initiative at our Boca conference in March, and in early May the CFTC began the process of seeking input from market participants and other interested parties. I look forward to consulting with FIA members on this issue over the coming months.
Developments like these make me hopeful that we are on the right track to make real, substantive progress on making regulations smarter and simpler without weakening the safety and stability of these important markets. This should be everyone’s goal.
