Newcastle Law School PGR Conference 2014 ‘The Challenges for Legal Thought in a Contemporary Society’ MACROPRUDENTIAL SUPERVISION OF OTC DERIVATIVES MARKET IN THE UK: THE RISK CYCLE Ligia Catherine Arias Barrera PhD Candidate University of Warwick 4 th April 2014

Introduction The reform of the Financial Regulation and Supervision Regime in the UK started by proposing the introduction of a new approach to financial regulation - one which is based on clarity of focus and responsibility, and which places the judgement of expert supervisors at the centre of regulation. Hence, the responsibility for financial stability rests in the Bank of England (BoE) and its Financial Policy Committee (FPC), and the Prudential Regulation Authority (PRA). Moreover, responsibility for conduct of business will still sit with the new Financial Conduct Authority (FCA). Regarding the Central Counterparties, the competent authorities are the Bank of England and the Financial Conduct Authority

OTC Derivatives Market Definition of OTC Derivatives Smaller and less regulated than the stock exchange derivatives market Regulation of Central Counterparties CCPs – market intermediaries.

Regulation and Supervision of the OTC Derivatives Market in the UK Strategies: Risk-based regulation Judgement-led regulation Authorities: Bank of England (BoE) Financial Conduct Authority (FCA)

Risk-based Regulation Risk-based regulation is ‘a type of regulation that prioritizes regulatory actions in accordance with the assessment of the risk that regulated firms will present to the regulatory body’s achieving its objectives’ 1. Requires a strategy of regulation focused on the quality of a firm’s internal controls. Motivation of national authorities – Accountability of regulators ___________________________________ 1. Julia Black, ‘The Emergence of Risk-Based Regulation and the New Public Risk Management in the United Kingdom’ (2005) Public Law 512.

Risk-based regulation Challenges 2 Two stages: 1. Identification and evaluation of risks 1.1 Matching statutory objectives with key risks 1.2 Firms’ managerial attitudes- Meta-regulation 2. Implementation 2.1 Identifying intervention tools 2.2 Changing firms’ behaviour ___________________________________________________ 2. Robert Baldwin, Martin Cave and Martin Lodge, Understanding Regulation (Oxford University Press, 2012) 281

Macro-Prudential Supervision of the OTC Derivatives market in the UK Macro-prudential supervision can be broadly defined as the ‘oversight of the financial system as a whole’ 3. The aim is to have the overall picture of the system risks and the interconnectedness between financial institutions 4 Role of the Bank of England (BoE) ___________________ 3. Martin Wolf, ‘Seven Ways to fix the System’s Flaws. Financial Times (London, 23 January 2012). 4. Mad Andenas and Iris H-Y Chiu, The Foundations and Future of Financial Regulation: Governance for Responsibility (Routledge, 2014)

The BoE has set out some Key Supervisory Pillars anticipating that ‘its supervisory effort is based on its assessment of where risks to financial stability are greatest’ 5. Although the emphasis is on counterparty credit risk management for CCPs, in general the supervision lies on systemic risk management through principles of: governance, management of operational risk, continuity of service and adequate rules in case of participants’ default. __________ 5. Bank of England, ‘The Bank of England’s approach to the supervision of financial market infrastructures (April 2013) Role of the Bank of England

The Role of the Bank of England The Bank of England issued the Annual Report 6 on the supervision of Financial Market Infrastructures to set out how the Bank has exercised its responsibilities and more importantly how it has met its financial stability objective through its supervision of recognised Clearing Houses. _____________________ 6. The Bank of England’s supervision of Financial Market Infrastructures. Annual Report. March 2014

Bibliography Books Arner D W, Financial Stability, Economic Growth, and the Role of Law (Cambridge University Press 2007) Avgouleas E, Governance of Global Financial Markets: The law, the economics, the politics (Cambridge University Press 2012) Baldwin R; Cave M and Lodge M, Understanding Regulation: Theory, Strategy and Practice (Oxford, Second Edition 2012) Barth J, Caprio G and Levine R, Guardians of Finance: Making Regulators work for us (The MIT Press 2012) Stuart Bazley S and Haynes, A Financial Services Authority regulation and risk-based compliance, (Haywards Heath : Tottel, 2 nd c2007) Articles Awrey D, The Dynamics of OTC Derivatives Regulation: Bridging the Public-Private Divide (European Business Organisation Law Review 2010) Black J and Rouch D, The development of the Global Markets as Rule-Makers: Engagement and Legitimacy (Law and Financial Markets Review, 2008) Black J. Enrolling actors in regulatory processes: Examples from UK Financial Services Regulation (Public Law 2003) Black J, ‘ The Development of Risk Based Regulation in Financial Services: Canada, the UK and Australia’ A Research Report (September 2004) Black J, The emergence of risk-based regulation and the new public risk management in the United Kingdom (2005 Public Law 512, 2005)

THANK YOU Ligia Catherine Arias Barrera PhD Candidate University of Warwick