Implementing Dodd-Frank and EMIR Regulations for OTC Swap Market Participants

Regulatory changes impacting the OTC derivatives markets, as introduced by the Dodd-Frank Wall Street Reform and Consumer Protection Act in the United States and the European Market Infrastructure Regulation (EMIR) in Europe, are reshaping the way dealers and end-users leverage these instruments for risk hedging and trading activities. The following regulatory-driven mandates are transforming the historically bilaterally traded global OTC derivatives market.

  • All OTC derivatives trade data must be routed and stored in a designated swap data repository (SDR). As of March 2013, the three leading repositories to support both CFTC and EMIR reporting requirements were: 
  • The introduction of centralized clearing through a central counterparty (CCP) that will decrease counterparty and settlement risks, which in turn will decrease overall systemic risk. 
  • The establishment of a central limit order book (CLOB) trading module called a Swap Execution Facility (SEF) through which the standardization of derivatives instruments will drive transparency in pricing and liquidity.

SWAP MARKET PARTICIPANTS RESPOND TO CHANGES

As we move through 2013, the final stages of Dodd-Frank rule implementation regarding the trading of OTC derivatives (i.e. swaps trading on SEFs, additional instruments subject to mandatory clearing via CCPs) are now in flight but have created several conundrums for the industry to consider: 

  • Many OTC swap market participants have been utilizing existing listed derivatives exchanges to trade and hedge part of their economic exposures. These OTC swap market participants have posted margins and/or collateral
    at these exchanges’ clearinghouses and find it very expensive to re-post at the newly formed CCPs as required by the Dodd-Frank Act. Furthermore, regulations prohibit them from posting just one set of collateral across asset
    classes and net out their margin requirements between the exchange clearinghouse and the CCP.
  • Futures Contracts (even though not an OTC derivatives product) will continue to promote greater price transparency, regulatory certainty, standardization, liquidity and capital efficiency via netting margin requirements of listed derivatives contracts across all asset classes at the exchange clearinghouse.
  • It is commonly recognized by all industry participants that there are additional costs, such as technology and operations, associated with setting up the proper infrastructure to facilitate efficient trading, clearing, settlement and meeting additional collateral and margin requirements.