James Rundle: Cross-Country Marathons

The big news in the derivatives world this month has been the US Commodity Futures Trading Commission (CFTC) and the European Commission (EC) agreeing that, due to the broadly similar regimes regarding derivatives trading in both regions, regulatory substitution can take place. To put it simply, that means buy-side and sell-side firms can use their home regulator’s rules rather than having to comply with two different sets of laws. It’s been a relief to market participants, some of whom have been quite vocal about the fact that they may have to break the law in their own country to comply with Dodd–Frank provisions regarding US counterparties, but it’s not fait accompli just yet.

Questions still remain over reporting and margin requirements for central counterparties, and the CFTC hasn’t given a blanket pardon to firms that fall under the Markets in Financial Instruments Directive (Mifid) or the European Market Infrastructure Regulation (EMIR). Some instruments and instances will have to be examined on a case-by-case basis, and although the agreement was extended to other regulatory jurisdictions such as Hong Kong and Australia, Singapore was notably absent.

Regional Wrangling
The issues of extraterritoriality aside, a lack of harmonization in regulatory approaches has been a consistent thorn in the side of technology professionals on the sell side. Take Asia-Pacific, for instance, where the lack of a federalized structure like that in the US, and a pseudo-federal structure in the EU, means that each nation has its own set of laws and conventions that need to be followed. What may be the norm in Japan isn’t necessarily the case in Korea, for example, and the divergence of market norms can be startling.

Of particular issue are the various laws regarding data privacy. Some are moderately “Westernized,” of course, such as in the Australian market. But not everywhere—Singapore has particularly strict laws regarding the movement of data outside of national borders, while Chinese restrictions around the identification of counterparties make it nearly impossible to comply with reporting requirements. No-action letters from the CFTC help to assuage the problems, but they’re only a Band-Aid for the wound, not the antiseptic needed to heal it properly.

Spaghetti Junction
This kind of regulatory fragmentation, essentially, leads to expense. If a country says that you can’t move data outside of its borders, and it has to be massaged or cleaned by personnel registered with the home authority, then basic market utilities such as datacenters become problematic. Rather than using a regional hub, for instance, localized structures are essential, and that comes with a price tag that proves a bit too dear for some.

Until there is more agreement on harmonization, rather than implementation, the complexity of compliance will continue to present challenges, and expansion will be faltering.

What are the solutions? The vendor side will tell you that modularity and flexibility is critical when it comes to designing infrastructures, while the end-users say it’s about picking your markets wisely. Both are right.  But both viewpoints disregard the basic conceit of the problem, which is that of a conflicted approach to global regulatory reform. It’s all well and good to have Group of 20 mandates regarding central clearing, for instance, and they can be accomplished in an Anglo-American context. But they don’t take the idiosyncratic nature of other regions into account, and it causes issues. Until there is more agreement on harmonization, rather than implementation, the complexity of compliance will continue to present challenges, and expansion will continue to falter.