22 Feb 2011
Kevin Neville's latest blog appeared in FX-MM on the uncertainty surrounding OTC regulation, banking regulation in general and the costs and technology challenges involved in complying
The uncertainty surrounding OTC regulation, banking regulation in general, and the costs and technology challenges involved in meeting them, is a healthy petri dish for POV's and blogs from many industry observers, like myself. I have always been a fan of regulation, because not only does it provide the loose cannons of society with some rules they mustn't break, but it also gives the doves amongst us some working boundaries that help remove their moral concerns.
However, the rule of regulation is far too often applied at too detailed a level that encourages arbitrage, becomes expensive to comply with and very expensive to enforce. Take the example of tax legislation. We have tomes of detail, produced and changed regularly, but essentially it enforces a simple premise; we are a society and society pays for itself through taxation. So why not have a simple tax regime where any inbound money incurs a tax of x% (perhaps with a scale), any outbound money incurs a surcharge of x% (with a scale) - and that's it.
A one paragraph law that seems to be quite difficult to avoid, misinterpret and misapply. The same is the case for OTC regulation. Why not construct a regime that encompasses the basic premise that Senators Dodd and Frank wanted to inscribe in law; that is, we would like more visibility of what you are all getting yourselves involved in.
Just recently, Gordon Brown (intelligent, financially savvy and at the top of our decision tree at the time of the collapse) admitted that he had no idea how entangled all our banks were through opaque trading processes. Well, I was an OTC Equity derivative trader for about 15 years and I knew full well that my bank was exposed, in secret, to a plethora of institutions in what effectively was a massive ball of string with no ends. How did I know this? Visibility. I had a complete view of the exposures through our OTC bilateral trades and this is what the Dodd Frank and EMIR regulation is striving for, which I believe is a powerful argument. And to that end, what asset classes should be involved? It seems FX has swerved Dodd Frank but not EMIR. That's a shame.
I don't think there is good reason why any particular asset should be exempt, let alone the only de facto true global asset - FX. If it is to be the only asset that is exempt from Dodd Frank then I can see a whole new class of complex FX OTC structures being created that includes a vanilla OTC Interest rate swap, which is then not eligible for clearing.
This could provide the same payouts, and even have a nice bit of FX protection wrapped in, but be opaque to other market counterparties and relatively invisible to the authorities. I say bring on regulation, but bring it in just one medium-sized book that applies to all asset classes please.
