The FSA and HM Treasury have issued a joint response to the Commission Consultation Document entitled Possible initiatives to enhance the resilience of OTC derivatives markets.
While agreeing that steps need to be taken to strengthen counterparty risk management and market transparency as a means of protecting financial stability, and broadly approving the proposals set out in the consultation, this response contains an outline of the key steps needed to strengthen the OTC derivatives markets, as envisaged by the FSA and HM Treasury. The response outlines four key issues that should be addressed in attempting to achieve the main objectives of regulatory reform i.e. the reduction of systemic risk and the improvement of overall transparency:
- Further standardisation of contract and economic terms.
- Greater use of CCP (central counterparty) clearing for clearing-eligible products.
- Strengthened risk management for non-CCP-cleared products.
- Increased transparency to the market and to regulators.
There are three principal ways, according to the response, in which to meet these objectives:
- The application of capital requirements which are proportionate to the risks assumed.
- Work must continue with market participants to improve existing arrangements, particularly in relation to risk management processes such as collateralisation.
- If the authorities eventually form the view that the first two methods, which are essentially voluntary, have not achieved their public policy objectives, regulatory measures should be considered and these could include imposing minimum risk management standards, and transparency and reporting requirements.