In 2009, the leaders of the G-20 committed to reforms in the over-the-counter (OTC) derivatives market to improve transparency, mitigate systemic risk, and protect against market abuse. The intent of this new report by IOSCO is to help further these objectives by providing high-level international standards for the regulation of market participants that are in the business of dealing, making a market or intermediating transactions in OTC derivatives (OTC derivative market intermediaries, or DMIs). IOSCO is the leading international policy forum for securities regulators is recognised as the global standard setter for securities regulation. The organization's membership regulates more than 95% of the world's securities markets in 115 jurisdictions and its membership continues to expand.
Historically, market participants in the OTC derivatives market have, in many cases, not been subject to the same level of regulation as participants in the traditional securities market. This lack of sufficient regulation allowed certain participants to operate in a manner that created risks to the global economy that manifested during the financial crisis of 2008. This Report focuses on the regulation of DMIs, taking into account the distinctions between the OTC derivatives market and the traditional securities markets, and the differences in jurisdictional approaches of international market authorities. The recommendations in the Report are intended to address:
DMI obligations that should help mitigate systemic risks;
Requirements intended to manage counterparty risk in the OTC derivatives markets; and
Protecting participants in the OTC derivatives markets from unfair, improper or fraudulent practices.
In particular, the report focuses on the market participants who should be regulated as DMIs, given their type and level of involvement within the OTC derivatives market, and describes the substantive areas that generally comprise regulation. The regulation of DMIs should be primarily focused on areas where capital, counterparty or client money and public confidence may be most at risk.
The report provides a description and definition of the market participants who should be considered DMIs, including a discussion of the characteristics distinguishing DMIs from traditional securities market intermediaries. Moreover, the report makes recommendations covering :
Capital standards or other financial resources requirements for non-prudentially regulated DMIs;
Business conduct standards;
Business supervision standards; and
Cross-border consistency among market authorities with respect to the regulation of DMIs is essential to successful oversight of the global OTC derivatives market particularly because many DMIs operate in multiple jurisdictions.
The report draws on the extensive work IOSCO has done on traditional securities market intermediaries, in an effort to harmonize the recommendations applicable to DMIs and to avoid the creation of unnecessary burdens on entities that act as both traditional securities market intermediaries and DMIs.
Consistency among market authorities with respect to the regulation of DMIs is essential to the successful oversight of the global OTC derivatives market particularly because many DMIs operate in multiple jurisdictions.
The report makes some 15 or so specific recommendations, which include the following:
1. DMIs should generally include those who are in the business of dealing, making a market or intermediating transactions in OTC derivatives. However, DMIs should not include end-users and market participants who enter into OTC derivatives transactions but are not engaged in the business of dealing, making a market or intermediating transactions.
2. DMIs should be subject to registration or licensing and applicable substantive regulations and/or requirements and standards once registered or licensed in some form by the relevant market authority or authorities, recognizing that in certain limited circumstances full application of substantive regulations and/or requirements and standards may not be appropriate for certain types of entities.
3. Registration or licensing requirements applicable to DMIs should be tailored to OTC derivatives activities.
4. The registration or licensing of DMIs should establish minimum standards and require DMIs to provide and update information with regard to their OTC derivatives activities to regulators to assist them in determining whether registration or license should be granted and/or revoked. All registering or licensing authorities should have the power to grant or reject and suspend or withdraw the registration or license of DMIs registered or licensed by such authority.
5. Relevant material information on licensed or registered DMIs should be made publically available. If a DMI registered or licensed in its home jurisdiction is carrying on OTC derivatives business in another jurisdiction in which the DMI is not registered or licensed, the market authority of the host jurisdiction in which the DMI is carrying on business should ensure that there are appropriate supervisory arrangements in place for the OTC derivatives business carried on by that DMI. These arrangements should take into account how the DMI is supervised in the host jurisdiction and any cooperative arrangements in place between the market authorities of the home and host jurisdictions. Market authorities should closely cooperate to identify overlaps, conflicts and gaps between jurisdictions with respect to cross-border issues relating to DMI supervision and to ensure that the DMI’s activities in the host jurisdiction are adequately supervised. It is further recommended that jurisdictions coordinate their approaches via multilateral or bilateral channels to reduce overlaps and conflicts, to the extent possible.
6. Market authorities should consider imposing some form of capital or other financial resources requirements for DMIs that are not prudentially regulated that reflect the risks that these intermediaries undertake.
7. DMIs should be subject to business conduct standards. These standards would include, among other things, prohibitions against fraud, misrepresentation, manipulation and other abusive practices.
8. Business conduct requirements should be tailored, as appropriate, for the OTC derivatives market. This could be based on the reasonable assessment of the nature of the party dealing with a DMI or on the complexity of and the risk associated with the specific OTC derivatives market product or service.
9. For cleared OTC derivatives transactions, DMIs should segregate collateral belonging to clients from their own proprietary assets and employ an account structure that enables the efficient identification and segregation of positions and collateral belonging to DMI clients. Where applicable and possible, DMIs should have in place procedures to facilitate the rapid transfer or porting of cleared client positions and collateral.
10. DMIs should be required to have effective corporate governance frameworks designed to ensure appropriate management of OTC derivatives activities within the DMI.
11. DMIs should be required to design supervisory policies and procedures to manage their OTC derivatives operations and the activities of their representatives.
12. DMIs should be required to maintain risk management systems and organization to properly identify and manage their OTC derivatives related business risks.
13. DMI’s management should be required to establish, maintain and apply policies, procedures and systems of control sufficient to provide reasonable assurance that the DMI and each individual acting on its behalf are competent and comply with applicable regulatory standards and the DMI’s internal policies and procedures.
14. DMIs should be required to develop and maintain an effective business continuity plan, based on their size, risks, and the nature of their operations, to allow them to mitigate, respond to and recover from business disruptions or disasters.
15. DMIs should be required to retain OTC derivatives transaction records and be able to provide them in a timely, organized and readable manner. The record retention period for OTC derivatives transactions should apply for a specified period after its termination, maturity or assignment.