Sea of Change Regulatory reforms – charting a new course International OTC derivatives reforms Chris Bates, Partner, Clifford Chance, London September 2012

Clifford Chance Forces shaping regulation of OTC derivatives 2 Regulation is being shaped by several powerful forces  The financial crisis  The euro crisis  The G20 agenda  Global rebalancing  Competition policy  Politics  Differing views from global regulatory bodies The effects are beginning to profoundly alter the shape of the OTC derivatives market There is a lot of legislation and still a long way to go......

Clifford Chance Market reform Clearing* Trading* Reporting* Margining* Risk mitigation Transparency Licensing Capital and structure Basel III* Bank structure (Volcker, US push-out, Vickers, Liikanen) Recovery and resolution* Other Uncovered sovereign CDS Financial Transaction Taxes FATCA Etc. The international agenda *G20 agenda item 3 International OTC derivatives reforms

Clifford Chance Sea of Change Regulatory reforms – charting a new course “All standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest. OTC derivative contracts should be reported to trade repositories. Non- centrally cleared contracts should be subject to higher capital requirements.” G20 Pittsburgh, September 2009 Market reforms – G20 commitments 4

Clifford Chance  Obligation for counterparties to clear eligible OTC derivatives with registered central counterparties (CCPs)  Obligation to execute eligible transactions through a trading system, not bilaterally  Obligation to report all transactions to a registered trade repository  Obligation to collect/post initial or variation margin on uncleared transactions  Regulation of confirmation process, portfolio reconciliation, trade compression and client documentation  Pre- and post-trade transparency for OTC transactions  Position limits/position management powers for commodity derivatives  Licensing or registration requirements for dealers and systemically important end-users  Business conduct rules for market participants, extension of market abuse rules  Regulation of CCPs and trade repositories Simple instructions, complex outcomes 5 International OTC derivatives reforms

Clifford Chance Different pace of reform around the world  US, EU, Asia  Clearing, reporting, margining vs. trading, transparency Scope issues  Instruments: e.g. FX, physical commodities and securities  Entities: e.g. treatment of end-users, intra-affiliate trades, pension funds, central banks Margining of uncleared trades  Initial margin and collateral thresholds Extraterritoriality and overlapping, conflicting rules  Different approaches to territorial nexus e.g. location of counterparties, arranger, transaction underlying  Extra-territorial application of licensing rules Regulation of CCPs and trade repositories Points of difference

Clifford Chance Basel III supplemented by national initiatives to raise bank capital  EU and US stress tests  Additional capital buffers e.g. UK, Sweden, Austria, Switzerland More, better quality capital and enhanced deductions from capital  Focus on equity and additional buffers, including G-SIB buffers  Plus unweighted leverage ratio Increased risk weights for assets affect OTC derivatives  CVA: credit valuation adjustment  Additional capital charge for exposures to large financial institutions  Capital charges for client business cleared with a CCP  Trading book review Liquidity risk regulated through liquidity coverage ratio and net stable funding ratio Basel III 7 International OTC derivatives reforms

Clifford Chance US Volcker rule: bans proprietary trading and sponsorship of private funds Push out rule: limits OTC derivatives in insured bank UK Mandatory ring fencing of retail deposit-taking activities Limits on derivatives activities of ring- fenced entities EU Mandatory subsidiarisation of trading activities (press reports) Bank structural initiatives *G20 agenda item 8 International OTC derivatives reforms

Clifford Chance International convergence of resolution regimes  Financial Stability Board publishes key attributes Requirement for recovery and resolution planning  Possible resulting structural changes to banks to facilitate resolution Recognition that ordinary insolvency regimes inadequate for systemically important institutions  US FDIC/orderly liquidation regime, UK Banking Act, German regime, EU proposed directive Debate over the role of “bail-in” as a resolution tool  Write down of junior and senior liabilities or conversion into equity  Impact on derivatives Recovery and resolution 9 International OTC derivatives reforms

Clifford Chance Restriction on banks’ derivatives capacity  Client and bank response may result in regional booking silos  Reduction in product range  Increased barriers to entry for smaller market participants Increasing importance of CCPs  Focus on financial stability issues and market structure Possible new market entrants: “shadow banks” Winners and losers Market outcomes 10 International OTC derivatives reforms

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