Following the Global Financial Crisis, regulators are committed to reduce the likelihood and severity of future crisis. In the area of financial derivatives, regulation is focused on increasing transparency, strengthening market infrastructure, and reducing systemic risk. In our book ‘Regulation and Supervision of the OTC Derivatives Market’, we are looking at these post-crisis regulatory reforms.
Our focus is the major transformation of regulation and supervision of the over-the-counter derivatives market (OTCDM) in the UK and the US, and the consequent move towards the regulation of Central Counterparties (CCPs) as new intermediaries of the market. This is a foundational discussion, revealing that the current UK and US regimes for CCPs are insufficient for a coherent risk-based approach, and highlighting, for the first time, the shortcomings of the UK and the US regimes of CCPs in the OTCDM.
Our central hypothesis is that the design and implementation of a coherent risk-based regime would allow regulators to use the approach as the ‘route-map’ of the regulation and supervision of CCPs. To achieve coherence, a risk-based regime must integrate the perceptions and attitudes of regulators and firms related to the risks manufactured in the OTCDM, and also how they should be managed and controlled. We use a normative risk-based approach to regulation as a methodological lens to analyse the regime, and specifically focus on prudential supervision, and the conduct of business rules governing CCPs in the OTCDM.
Our comments on the Dodd-Frank Act highlight that the incoherent adoption of risk-based approach to regulation affects the effectiveness of the US regime for CCPs. Such a regime does not follow the pace of events of ‘innovation risk’; in particular, the foreseeable changes FinTech will bring to the OTCDM and central clearing services. The second inadequacy of the US regime concerns the dual regulatory structure of the CFTC and the SEC, and the inadequate adoption of different and not well-coordinated regulatory strategies. We also analyse the cross-border implications of the US regime for non-US CCPs that provide clearing services to US market participants. Finally, we study the negative effects of the absence of a clearly defined resolution regime for CCPs.
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