Even with current high uncertainty, it is fair to expect that the G20 reforms, with some adjustments, will guide the path ahead of financial markets. Adjustments will respond to the lessons learned in the past few years, the effects of yet increased integration of financial markets, particularly from Asia, and technological developments. Enacting and enforcing G20 reforms will require increasing international cooperation across the whole process, from standard-setting, through regulatory, to supervisory cooperation, and growing deference across supervisors. All along this route, the EU continues to be in the lead. In derivatives, it has now fully unrolled and phased in a regulation (EMIR) implementing the G20 standards, and recently reviewed it to improve efficiency and reduce unnecessary burden. The EU has pursued regulatory convergence with Asia Pacific, and granted 16 equivalence decisions on CCPs, eight of them to countries in Asia Pacific. Equivalence decisions on margins are forthcoming.
Forecasting the path ahead is a daring task. Ten years ago, most forecasters missed the global financial crisis. One year ago, few did anticipate the UK would decide to leave the EU, or the actual outcome of the US elections. Uncertainty is very high.
Nevertheless, some guide posts are likely to lead developments in the coming months. We can expect the G20 reform commitments, aimed at ensuring financial markets’ stability and transparency, to continue to inform regulatory changes. It does not seem that the new US administration will significantly reverse legislation implementing the G20 reform, but global negotiations of further standards have slowed down and even stalled in the last few months. We can on the other hand expect targeted fine-tuning of the present rules, as regulators become aware of loopholes or unintended effects, as new issues arise from greater integration of financial markets, particularly in Asia, and as technology opens up new frontiers and associated risks.
In the area of derivatives, the EU enshrined the G20 principles in EU law with its EMIR (European Markets Infrastructure Regulation), addressing OTC (over the counter) derivatives margins, platform trading, capital requirements, central clearing, and trade repositories. EMIR entered into force in 2012 and implementation has been phased-in, the latest stage being the rules for margin requirements in late 2016. We have monitored implementation and launched two public consultations in 2015 and 2016. Building on them, we will put forward later this spring a recalibration to simplify some reporting and clearing requirements and to reduce disproportionate costs to some participants like non-financial counterparties, pension funds and small financial counterparties. The FSB (Financial Stability Board) is also conducting a comprehensive review on the effectiveness and side effects of reforms and will report to the G20 Summit next summer. The EU fully supports it.
Since the OTC derivatives market is global, advancing the reform for further stability and transparency requires international coordination at various stages of the regulatory process: in global standard setting, in the enactment of the standards at national level, and in the implementation by national supervisors.
Global standards: Negotiations of new standards will continue even though probably and regretfully at a slower pace. For example, negotiations on Basel IV, in spite of the progress achieved on many areas like credit risk, operational risk, or liquidity ratios, stalled on the discussion of an output floor as a further determinant of capital requirements. The US instead has pleaded for an 80 percent floor while the EU, as several other BCBS members, is unconvinced about the need for such a floor given the agreement on a leverage ratio, and hence cannot agree on a floor higher than 70 percent. More generally, the EU is in favour of a risk-sensitive approach that does not significantly raise capital requirements and maintains a level playing field.
Regulatory approximation: International cooperation is also necessary at the legislative stage to prevent divergent implementation of the agreed standards because those standards are not sufficiently detailed to be readily transposed into legal code, and because national legislative approaches and systems are often quite diverse. The EU has recently upgraded the regulatory dialogue that it holds with the US authorities, and has recently set up an EU-Asia Pacific Financial Regulators Forum with the countries of the region. An example of the benefits of regulatory convergence has been the common approach agreed in 2016 between the US CFTC (Commodities and Futures Trading Commission) and the European Commission on CCPs (central counterparties).
Implementation: Cooperation is still necessary at the enforcement stage particularly for companies operating cross-borders and hence subject to overlapping or inconsistent requirements emerging from the legislation in the various countries of operation. Several examples bear witness of EU’s openness to equivalence and deference. On CCPs the EU has granted equivalence treatment to eight Asia Pacific countries (Australia, Hong Kong, India, Japan, Korea, New Zealand, and Singapore), as well as to Japan’s common derivatives regime, and will issue in the coming months the first batch of equivalence decisions on margins for uncleared derivatives.
The EU supports the FSB principle of assessing equivalence and deferring supervision when the regulatory systems it deems them to be equivalent. In its assessments, the EU focuses on outcomes rather than line-by-line code equivalence, and it has recently issued principles that provide further clarity about its approach. First, the assessment focuses on risk net of mitigation, which involves evaluating the level of risk of the activities and markets involved, as well as the legal and supervisory mitigation instruments put in place by the authorities concerned. Second, equivalence is assessed on the rules (based on the CPMI-IOSCO [Committee on Payments and Market Infrastructures and International Organization for Securities Commissions] principles for financial markets infrastructure) but also on enforcement and supervision, to yield equivalent outcomes. Finally, equivalence requires that the country concerned has enacted a system to recognise third countries rules.
Antonio de Lecea is principal advisor to the European Commission’s director general for economic and financial affairs and European Union visiting fellow at the National University of Singapore’s Lee Kuan Yew School of Public Policy