Aug 5, 2013

Cross-Border Derivatives Regulation - A Checklist for Readiness

Watch the Video: Cross-Border Derivatives Regulation - A Checklist for Readiness

Udi Sela, Vice President of the Client Solutions Group joins Numerix CMO Jim Jockle to reflect on the current state of global derivatives regulations. The conversation spans a number of key issues as they relate to the US-EU cross border swaps rules, the proposed Financial Transaction Tax (FTT) and potential fall-out from CVA Exemptions. Udi explains where the regulations stand, who they impact and how they align with the overarching goals and original objectives of the G20.

Weigh in and continue the conversation on Twitter @nxanalytics, LinkedIn, or in the comments section.

Cross-Border Derivatives Regulation - A Checklist for Readiness Transcript:

Jim Jockle (Host): As we hit the summer months of August, the bull market is still rearing its head, gold is still pressured, and volatility is either up or flat. But, with me today to talk about some of the implications of the forthcoming regulations, as we're saying finally at implementation time, Udi Sela of Numerix. Udi how are you Sir?

Udi Sela (Guest): Fine. Glad to be here. Thank you.

Jockle: I am happy you're here. So let's just dive right in. Dodd Frank is now three years old. Basel III is approved in the U.S. We've had the watershed moment of the CFTC in terms of alignment or intend to alignment for cross-border rules. But, when we think back to the objectives set out back in G20 – we were going to have more centralized clearing, better transparency in trading – are these stated objectives now that all these regulations are coming to market, aligning with the overarching goals? 

Sela: Well we define the goals as what? To have safe trading and that public money will not be required again to save institutions. So of course the risk is always from under regulating to over regulating. So the question is "what is the impact on the cost of making business?" that's one thing. Second thing is, "Will it be harmonized across different geographies?"or "will there be regulatory arbitrage opportunities?" – when one would trade at one center, as oppose to another center to limit the cost of doing business. So I guess that these are the questions that we need to ask ourselves. And also there's the question, "do we favor now the listed markets as oppose to the OTC market?", because we give incentives or in other words we make the transacting via listed markets less costly. 

Jockle: So one can argue that, especially with the cross-border rules, we're moving closer to harmonization, and that's well on its way. And that's also under the control of the regulators themselves. But where are we on the cost of business. I mean presumably, costs now are going to rise.

Sela: Yeah so clearly, as you say costs will rise because there would be now additional cost for when it gets to margining. So every time my position exceeds a certain threshold, I'll be required to post additional collaterals right? And this would be for more trade types than there were previously. So clearly, this would impact the cost of trading.

Now if you think of those corporates that hedge - pension funds, the cost even for funding, could rise. For instance, if you look at corporates that use FX swaps, for funding purposes. So every time I have a surplus in my dollar account and a deficit in my euro account, I can use FX swaps in order to roll my positions and make sure that my balances in my bank account are balanced in a way that they don't have to pay charges for overdraft. So people use FX swaps a lot for funding.

Now, would that be subject to additional costs by, like a CVA charge. That's an issue. So that's one thing that I think would make sense to make sure the regulation is the same across different countries.

Jockle: So what's the timeline we're starting to see these implications flow through to the bottom lines of the corporates themselves?

Sela: So I think that, my understanding is towards the beginning of 2014, we'll see something already in Europe being implemented. If I recall correctly this is also the time of the FTT, so the financial transaction tax, also known as token tax, that the European Union wants to implement towards the end of the year so that's again, six months.

So I think, in this respect, Europe is a bit ahead of the curve and then I think that in the U.S., we still need to see what the concerns are between the SEC and the CFTC. What would be eventually implemented and also, you mentioned three years for Dodd Frank, anniversary if you like, but would it be softened because we hear that members of the house actually want to weaken a bit. Again because financial actors are lobbying against additional cost, and are concerned that this could put them at a disadvantage as oppose to other players in the global market.

Jockle: So if I'm sitting down and making a checklist for readiness. What should I be watching first? And why don't we just focus on corporates since we've spent a lot of time on them.

Sela: Yeah, so one thing we want to watch as a corporate, especially as a U.S. corporate, or as a corporate that is doing business in the U.S., would they be exempt from CVA charges or not? That would imply also to pension funds. What about the requirements in terms of cross-border activity?

When is the – it also depends on the derivatives that you trade, if you trade, as a corporate. So for instance when would FX options be obliged to trade as a part of a SEF, a swap execution facility, for now that's not the case. So you have to follow, I'd say you'd have to look at regulation coming out of Europe, such as EMIR, you want to look at the regulation coming out of the U.S. And you want to also check by the type of activity that you do, because regulation will not be just one block that is dropped in one location and that's it. It's something that evolves over time. So you need to see what kind of domains of your activity are now being liable to, or subject to the new regulation.

Jockle: Well Udi thank you so much for the insight and I think we all have a couple more things to talk about in the future as different implications as we're continuing to see the phased rollout if you will, of regulatory regime change.

Sela: Yes.

Jockle: We want to hear your thoughts. So if you're on twitter follow us along on @nxanalytics or on our blog where you can get feedback to any of the topics that we sit down and talk about today. Udi thank you so much.

Sela: Thank you.   

Jockle: And we'll see you next time.

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