World Federation of Exchanges- IOMA Conference Speech
Thank you very much for inviting me to speak today at the WFE IOMA conference.
I often feel out of place speaking at a conference attended by so many experts in the industry
A mere politician in a room full of practitioners and veterans of the regulatory sphere
Yet the area you work on has been shaped by decisions made by politicians, like me since 2010
When our heads of Government met in Pittsburgh in 2010 they chose to centralise OTC derivative risk in CCPs and in doing so CCPs were effectively designated as the possible saviour of the financial sector by the G20.
That’s a big responsibility
They worked on the basis that an unknown set of bilateral derivative contracts, all tightly woven together, would be of less risk to the system as a whole if they went through one central entity.
The logic was clear
If they knew what the risk was, they would be better placed to manage it.
However, CCPs were originally set up by industry
Not supervisors or regulators
And they performed their task well during 2010 for listed derivative products.
CCPs often as Self-Regulatory Organisations whose members’, or management boards, decided their business structures
Decided who their clearing members would be
Mandated their rights and obligations
Decided what products they could successfully clear and at what volume
While I am certainly not saying that they were unregulated pre 2010
Their success or failure was not deemed a matter of public interest in the same way as it is now
There was less scrutiny and less intrusive regulation and direct supervisor oversight.
When the G20 created a clearing mandate for derivatives
And picked which entities were going to be at the centre of the financial system
Politicians also created a responsibility for themselves to ensure,
to the best of their ability,
that the entities they chose – the CCPs
were as safe as they possibly can be.
Hence why we see the level of detail found in EMIR, the derivatives regulation in the EU.
However beyond the regulations in different jurisdictions,
there was also a recognition that this was a problem that needed to be solved by international jurisdictions working together.
The OTC Derivatives Regulators Group, with the lovely acronym – ODRG was established in 2009
The idea being that they would be a forum that would provide the means for cooperation, the exchanging of views, and the sharing of information
There are currently 57 supervisory organisations as members from 23 jurisdictions
And they have been working together
But we are a long way from a joined up, global approach to supervising and regulating CCPs
CPMI- IOSCO has many more members that the ODRG and has produced the Principles for Financial Markets Infrastructure that everyone here knows so well.
And again, these principles are really important.
They provide a base line for all market infrastructure
Yet they are principles
They sometimes give options that are mutually incompatible
Working in EU policy I know how difficult it is to get 28 different jurisdictions to agree detailed rules
It is often tempting to allow member state options
Or find a political fudge that moves the decision on to another level
But it is exactly these political fudges that end up causing problems in the future
A prime example of where the detail matters was the long and drawn out process the European Commission and the CFTC went through to find equivalence on CCPs
I know that both sides often claimed that wording in Dodd Frank or EMIR tied their hands and prevented them from acting differently
Yet this was often the result of unclear or imprecise drafting
Drafting where politicians had fudged it.
I am really glad that an agreement has now been reached between the US and the EU
Substituted compliance has been granted and
ESMA is in the process of recognising the US clearing houses
Yet I consider it a lesson in how not to negotiate, the lack of bilateral cooperation was obvious on occasions and is something to avoid
I believe that more detailed rules at an international level might have avoided a couple of those many years of uncertainty that occurred while the agreement was reached
More detailed rules may have been harder to negotiate within the OTRG, or CPMI IOSCO group
And they may have proved harder for national politicians to translate into their own domestic legislation
but more granular rules by supervisory experts in advance of political decisions would have created a more stable and resilient framework for global CCPs regulation and supervision
This observation has been one of the many reasons that I have spent the last two years focussing on shaping EU policy on CCP resilience, recovery and resolution
I have what happens when we as politicians make decisions in a vacuum and when we fail to work together
And what happens when independent supervisors aren’t put under enough scrutiny or given enough political direction
CCPs are now at the heart of the financial sector and crucial to risk mitigation and market stability and so developing the policy areas around resilience, recovery and resolution is critically important.
The European Parliament started this process with my report in 2013, where we laid out what a recovery and resolution framework needed to do
We established political priorities which were designed to guide the European Commission in their work in this field.
Not the details
The initial European Commission discussion paper of 2013 which they had worked on with experts from the finance ministries and supervisory bodies from around the EU confirmed our worst fears and confirmed that
We were a long way away from an agreed approach in the EU 28
The list of options being proposed for a tool box was long
And the favoured option was the one that we as politicians wanted to avoid
Namely, the use of taxpayers money
It showed what we needed to know and assess ahead of legislating. The overwhelming conclusion being that
It would not be acceptable at a political level to wait and see what happened should a CCP fail – the 3 Rs of resilience, Recovery and Resolution need addressing
We need to ensure a coherent resilience agenda for all CCPs and their clearing members
In the recovery phase all tools should be considered and evaluated for their usefulness and effectiveness in the hands of the CCP
And in the case of resolution, should it be necessary then, clear legal powers and decision making responsibilities should be agreed in advance and barriers to any action be identified and addressed.
It is clear however that in all three of these areas international cooperation will be essential
The immediate tendency from every financial supervisor and finance minister in a crisis will be to protect their own markets
The instinct to insulate their own banks and their domestic financial market infrastructure from what is going on in the wider world is real
that is the tendency that we need pre-arranged international agreements to deter against
We need to ensure that disagreements between the prudential supervisors of clearing members versus the market supervisors of the CCPs, versus the rights of the clients of clearing members don’t escalate out of all proportion in a crisis scenario
The incentives for each group are directly opposed to one another in CCP failure and
Yet maintaining the whole system is in everyone’s interests
The classic prisoners’ dilemma writ large on the global financial system
So we need to ensure that global regulators and supervisors with both prudential and markets experts collaborate in their work to seek convergence on rules for CCP resilience, recovery and resolution.
I would like to say that international cooperation is going well
That entities like the ODRG and CPMI-IOSCO are functioning perfectly, and achieving international consensus
But the battles so publically being fought between securities supervisors and central bankers over concepts like the supplementary leverage ratio,
Show that more political direction is needed
Markets supervisors and Central Banks may be independent entities in most jurisdictions but they are rarely unaccountable bodies
The mandates politicians have given them require them to be held to account.
As politicians we, would not be fulfilling our own responsibilities if we ducked this challenge.
Whilst I leave this topic with a plea for the technical experts to actively contribute to a comprehensive and granular set of parameters for both recovery and resolution of CCPs, ahead of possible legislative action, I would conclude with a thought –
Given the often fractious and fraught journey from G20 decisions to the legsiation being implemented globally and equivalence being finally granted – is there anyone in this room who would volunteer to start the process over?
That is what potentially the UK, home of one of the largest global financial markets, may be facing following a referendum on the UKs membership of the EU on June 23rd.
Will the UK still be in the EU in three months’ time?
Polls from different institutions come out daily showing the results tipping one way or another- although lately more polls show the UK electorate are increasingly likely to vote to leave.
Although I have broad concerns for what leaving the EU might mean including barriers that could be put up to things that we currently take for granted on trade, security and travel, and therefore risk the UK’s economic prosperity.
I’d like to turn to what it would mean from a financial services perspective?
Many in the city have claimed that a vote to leave means they will not have to comply with EU financial services legislation
Yet as you all know from other international jurisdictions
If you want to have access to the EU market, you have to comply with EU rules-
Whether directly, or by having national law which is compatible in effect.
We would need to enter dreaded equivalence negotiations once again, this time as a single country negotiating with the existing systems of other regions
Increasingly, much of EU financial services legislation is written as regulations
Meaning it is directly applicable and does not get transposed into member states law
This includes EMIR
Should we leave the EU, the UK would be in the unacceptable situation of not have any derivatives legislation on its statute books
We would therefore need to pass new laws
We would have to meet equivalence.
The fact that the US,
Has spent the past 4 years trying to meet EU equivalence standards for CCPs in the derivatives world
Should give a taste of what we should expect as a financial centre outside of the EU.
It would not be a given that the UK gets equivalence – even in an area that we have led globally.
Within the EU, the UK has often been the lone – yet loud and effective– voice fighting to retain open markets
Pushing for workable third country regimes and continuing negotiations when things get tough
If the UK weren’t in the room who within the EU will take up that mantle?
Will anyone? or will the walls of fortress Europe go up to other jurisdictions including the UK outside of the EU?
I would love to stand here and predict that the UK will vote to stay in a the EU
But I think the outcome is hugely uncertain
Column inches have been devoted to process and who is funding what side of the campaign
Yet facts are few and far between
This should not be led by politician’s personal emotional attachment - or not –
to the EU, but based on fact.
My constituents want to know the facts
What does membership of the EU actually mean?
What would leaving mean?
but those facts are not on the front page of the UK daily newspapers
A rather dull report from one of the city analysts, hidden on page 10 of a 20 page report
has attempted to quantify the loss to the UKs GDP growth of leaving the EU
This has been calculated as 1% per year for at least 5 years while the uncertainty continues with a significant currency depreciation
Yet more dull reports will give dry statistics on trade imbalances
The small print of board reports will give crisis planning on what large employers across the EU will do should there be a vote to leave.
But none of these are understandable or explainable on the streets of Cardiff or anywhere else in the UK.
Its hard to say what will ultimately decide the outcome of the referendum
Turnout will be a key factor, as we saw in the Netherlands last week when on a turnout of 32%, 64% voted against a free trade deal with the Ukraine,
- a vote that was seen as a proxy vote on a referendum on EU membership
The migration crisis and how well the EU responds to it in the coming months will continue to play a part
Terrorist attacks like those we faced in Paris and Brussels most recently will also contribute
Does being a member of the EU make you feel safer or more afraid in uncertain times?
Economically, that is the question that people will be asking themselves in the coming weeks.
Personally, I think the answer is clear
While there is a lot to dislike about the EU, and I fight every day to reform it, I think life outside would be considerably more uncertain than within.
I for one do not want to start over with regulating financial markets and participants post-crisis, but there is much at stake so any of you here in this room with a vote, I urge you to use it wisely and to ensure friends and family are aware of the wide consequences of this once in a generation referendum.
I’m happy to take questions on either CCPs or Brexit, or anything else anyone has a burning question on.