DerivAlert Blog

Q&A: OTC Derivatives Operations and the Pending Regulation

Jeff Zoller, Executive Sponsor of the Derivatives Working Group at ISITC (International Securities Association for Institutional Trade Communication), talks to DerivAlert about how the pending OTC derivatives regulation would affect operations and processing. 

Q: How will the pending regulation affect the back-office operations and processing of OTC derivatives?

A: Two key provisions of the recently passed legislation require (1) central clearing and (2) data collection and publication through clearinghouses or swap repositories. The industry had already begun working toward these objectives through the commitments outlined in the letters to the New York Fed and other regulators, so in a sense, we "saw it coming" and have been preparing for these requirements. However, much of the detail has yet to be defined – for example, how will "major swap participants" be defined; at what point in the trade will transparency via the clearinghouse or repository be required (e.g., time of execution v. end of day); will there be margining requirements for OTC derivatives that do not clear, etc.

Q: Does the industry need to invest in new technology for their OTC derivatives processing, collateral management, etc.?

A: Yes – in short, the industry will need to be prepared to trade electronically, clear centrally and report to a trade repository. The interfaces, infrastructure and operational processes to support these requirements need to be developed. In many cases, this will require new systems or modifications to existing systems. Additionally, modifications to order management systems may also be required to handle OTC derivatives. It is important to note that many firms have already begun this process.

Q: What concerns are you hearing from your members at the ISITC Derivatives Working Group?

A: The participants in the ISITC working group have been focused primarily on issues regarding the current central clearing participants' models for supporting buy-side trading and, more specifically, some of the issues faced by 40 Act funds with respect to the movement of collateral. Since most of the high level requirements in the legislation were expected, it has been a bit of a "wait and see" approach. The next few months will be quite busy in sifting through the details and in making sure firms understand the requirements.

Q: What will the industry need to do to be ready for the pending regulations?

A: The industry must monitor and proactively respond to the new regulatory requirements. It is important that firms do not underestimate the effort that will be required to select and onboard derivatives clearing agents and the CCPs. First, as there may not be one CCP that spans all instrument types, multiple CCPs may be required. Second, the sell-side is wary of a rush to get onboard as the implementation date approaches – a prospect that could prove logistically challenging. The Derivatives Working Group provides a valuable forum to discuss these details and talk with peer firms about how they are preparing.

Q: Are the pending mandates shifting the focus to OTC derivatives processing or has that always been one of the main concerns for the industry?

A: Automation of OTC derivatives has been a key priority for a number of years. The industry has worked well together to develop solutions to facilitate automation, define achievable targets and commit to such targets via the letters to the NY Fed and other regulators. Messaging capabilities and standards have also evolved quite a bit, with the Working Group taking a lead role in defining such standards. I don't believe that there were too many surprises in the legislation.

Q: What benefits and challenges can the industry expect from the pending OTC derivatives regulations?

A: One of the key benefits of central clearing is portability – in the event of default, positions and collateral will be transferred to other counterparties. While it is expected that a central clearing model will reduce the operational workload with respect to collateral management, it is somewhat expected that the overall transaction costs for OTC derivatives will increase. The key challenges are in the implementation of this model – how much will exchange-traded, centrally cleared OTC derivatives look and feel like listed futures; can positions be traded across CCPs; what is the overall impact to non-cleared OTC derivatives, etc.

Q: What are your main goals at the ISITC Derivatives Working Group at the moment?

A: The ISITC Derivatives Working Group will be focused on understanding the key provisions of the recently passed legislation and the impact to our members. Accordingly, we will continue to invite industry experts to our Working Group meetings to help address our members' concerns and questions. ISITC continues to work with other industry groups to address the current issues associated with central clearing for the buy-side, and we'll continue our work on messaging standards, extending our best practice recommendations to additional instrument types.