SEC Chair Lays Out the Future of OTC Derivatives Regulation

In an address in February before the Practicing Law Institute, SEC Chairman Mary Schapiro outlined for the audience the Commission's plans to build, from the ground up, a new regulatory regime for over-the-counter derivatives. The innovative and heretofore lightly regulated OTC derivatives market has long been seen by Schapiro as a risk to the financial system. In particular, she sees systematic risks posed by: the opacity of the derivatives market; weak or non-existent capital, margin and clearing and settlement requirements; and the concentration of derivative transactions among a relatively small number of institutions.

Title VII of the Dodd-Frank Act directs the SEC to regulate in this area. And the Commission has joined forces with the CFTC to write rules intended to reign in the systematic risks of the OTC derivatives markets by:

• Increasing centralized clearing of swaps and ensuring that capital and margin requirements reflect the true risks of these products.
• Improving transparency to regulators and to the public by shedding light on opaque exposures and assisting in developing more robust price discovery mechanisms.
• Increasing investor protection by enhancing security-based swap transaction disclosure, mitigating conflicts of interest, and improving our ability to police these markets.

According to Schapiro, in 2012, the SEC and CFTC will complete the last remaining proposals regarding capital, margin, segregation and recordkeeping requirements, and embark on the next steps in implementing Title VII:

• I expect the Commission to soon finalize rules that further define who will be covered by the new derivatives regulatory regime and, next, what will constitute a security-based swap. 

• Finalizing these definitions will be a foundational step, defining the scope of the new regulatory regime and letting market participants know whether their current activities will subject them to the substantive requirements we will be adopting in the coming year. 

• Beyond this, the Commission staff is continuing to develop a plan for how the rules will be put into effect. The plan should establish an appropriate timeline and sequence for implementation and avoid a disruptive and costly “big bang” approach.

Schapiro stressed that compliance periods for this new OTC regime will be appropriately generous.

Complicating the SEC's task of regulating the OTC markets are the international implications of the new restrictions.

Given the global nature of the OTC derivatives markets, and the potential for regulatory arbitrage by market participants, the Commission is working closely with their counterparts in other countries to craft, not "one-size-fits-all" regulations, but principles based restrictions that retains flexibility, while reigning in potential systematic risks and abuses.

We are working hard to coordinate with our foreign counterparts to help achieve consistency among approaches to derivatives regulation. There has been significant progress on the international level. Our cross-border approach must strike a balance between sufficient domestic regulatory oversight and the realities of the global market. A “one-size-fits-all” approach is neither feasible nor desirable.

In the near term, the Commission intends to address the most salient international issues in a single proposal. This will give interested parties an opportunity to consider, as an integrated whole, our approach to cross-border transactions and the registration and regulation of foreign entities engaged in such transactions with U.S. parties.