Regulatory Fragmentation Heightens Derivatives Market Risk – ISDA

Policymakers should reduce the gap between national regulations and global standards, and adopt a risk-based framework for the recognition of comparable regulatory regimes.

ISDA (the International Swaps and Derivatives Association) has released a new paper highlighting jurisdictional differences in the implementation of global standards for derivatives, and recommending a series of steps that can be taken to address regulatory fragmentation.

Since G20 policymakers came together and agreed on a globally consistent regulatory agenda for derivatives 10 years ago, “substantial progress” has been made at the national level to make derivatives markets are safer, more transparent and more resilient, ISDA says. The reforms have focused on five key areas: central clearing, capital, margin, trade execution and trade reporting.

“However, these and other regulatory reform efforts too often differ in scope, substance and timing across jurisdictions. This regulatory fragmentation results in added cost, complexity and inefficiency, contributes to market fragmentation, and ultimately increases risk for market participants and the financial markets,” the paper says.

Indeed, fragmentation has been a key focus of the Japanese G-20 presidency in 2019. To contribute to the dialogue on the issue, ISDA has conducted a comprehensive review of global derivatives regulation to identify where and how regulatory driven market fragmentation has impeded risk management and imposed excessive costs and burdens on market participants without commensurate regulatory benefit. The examples, laid out in the paper’s annex, cover key areas including clearing, trade execution, data and reporting, netting and benchmarks, among others.

While it may not be possible or desirable to completely eliminate all national differences in regulation, ISDA notes that fragmentation may occur when differing regulatory requirements force firms to develop and implement different systems and solutions, even when the requirements are implemented to meet a global standard.

“Data and reporting is an obvious example. If all jurisdictions require market participants to report generally the same information to trade repositories, but each requires different data forms and formats in which such information should be reported as part of its rule set, then firms will incur significant expense in complying with myriad rules.”

Such discrepancies also impact the ability of regulators to monitor risk on a global basis, ISDA says.

Fragmentation may also occur when overly burdensome rules are applied in jurisdictions with small trading volumes that pose little risk and merely serve to increase the cost of doing business and make access to derivatives risk management more difficult.

ISDA believes policymakers should reduce the gap between global standards and national regulations to ensure greater consistency in implementation, and adopt a risk-based framework for the evaluation and recognition of the comparability of derivatives regulatory regimes across borders.

Further, global standard-setting bodies (FSB, IOSCO, CPMI, BCBS) should establish a process that would enable national regulators to implement equivalency and substituted compliance determinations in a predictable, consistent and timely manner.

The paper is available here.

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