The Politics of Derivatives Regulation after the 2008 Crisis
EDITED BY ERIC HELLEINER
STEFANO PAGLIARI
IRENE SPAGNA
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CONTENTS
List of Illustrations vii
List of Tables ix
Preface xi
Abbreviations xiii
Contributors xvii
Introduction—Governing the World’s Biggest Market: The Politics of Derivatives Regulation after the 2008 Crisis 1
Eric Helleiner, Stefano Pagliari, and Irene Spagna
1. Becoming the World’s Biggest Market: OTC Derivatives before the Global Financial Crisis of 2008 27
Irene Spagna
2. Financial Regulatory Cooperation: Coordination of Derivatives Markets 54
Elliot Posner
3. Global Markets, National Toolkits: Extraterritorial Derivatives Rule-Making in Response to the Global Financial Crisis 82
Matthew Gravelle and Stefano Pagliari
4. Power Plays from the Fringe: East Asian Responses to Derivatives Regulatory Reform 107
Yu- wai Vic Li
5. The Second Half: Interest Group Conflicts and Coalitions in the Implementation of the Dodd-Frank Act Derivatives Rules 137
Stefano Pagliari
6. The Politics and Practices of Central Clearing in OTC Derivatives Markets 168
Erin Lockwood
7. Positioning for Stronger Limits? The Politics of Regulating Commodity Derivatives Markets 199
Eric Helleiner
8. A Web without a Center: Fragmentation in the OTC Derivatives Trade Reporting System 226
Peter Knaack
Index 257
ILLUSTRATIONS
1.1 The global OTC derivatives market 31
1.2 The markets for OTC and exchange-traded derivatives 31
1.3 The global OTC derivatives market by counterparty type (% of notional amounts outstanding) 32
1.4 Gross market value of OTC derivatives in function of different types of derivative instruments (billion USD) 33
5.1 Firms lobbying CFTC and SEC over derivatives rules (2010–2014) 147
5.2 Groups most frequently lobbying (meetings + letters) the CFTC and SEC over implementation of derivatives rules (2010–2014) 148
5.3 Network of groups lobbying over SEC and CFTC derivatives rules 149
5.4 Numbers and links among groups lobbying the CFTC and SEC (meetings + letters) across different derivatives rule-making (2010–2014) 151
6.1 Bilateral and centrally cleared networks 187
6.2 Links between banks and global CCPs 188
8.1 International financial network, portfolio assets 233
8.2 CDS network on EU sovereign reference entities 235
8.3 ISDA’s role in the agreement on a temporary stay on early termination rights 238
8.4 The current global TR network 248
TABLES
I.1 Core aspects of the G20 agenda for derivatives regulatory reform 6
I.2 The political dynamics of post-2008 derivatives regulation 22
2.1 What is to be explained? Patterns of cooperation in implementing G20 principles for derivatives regulation 61
PREFACE
Since the 2008 global financial crisis, scholars have written extensively about various post-crisis regulatory reforms designed to improve the stability and resilience of financial markets. Within this literature, however, the extensive efforts to reform the regulation of derivatives markets have received less attention than other dimensions of the post-2008 reform agenda. This relative neglect is unusual given the significance of derivatives markets in the crisis and in the contemporary global economy more generally. We think it is also unfortunate given the fascinating nature of the politics surrounding post-2008 derivatives regulatory reforms. As the momentum for reforming the regulation of these enormous markets weakens, we believe that it is more important than ever to improve understandings of the politics of derivatives regulation. This volume aims to contribute to that task.
The book is a product of a very fruitful collaboration among the contributors to this volume that began with a workshop at the Balsillie School of International Affairs in September 2015. We are extremely grateful to all the authors in this volume for writing such interesting chapters. For their contributions to that initial workshop and very helpful comments, we also extend enormous thanks to Derek Hall, Dave Kempthorne, Jonathan Kirshner, Kate McNamara, Sylvia Maxfield, and Heather Whiteside. We also thank the Balsillie School of International Affairs for funding the workshop and the Social Sciences and Humanities Research Council of Canada for research support. Many thanks as well to Dave McBride at Oxford for his support of this project as well as to Claire Sibley for her help and the anonymous reviewers of the initial draft of this manuscript for their very useful suggestions and comments.
Eric Helleiner, Stefano Pagliari, and Irene Spagna April 2017
ABBREVIATIONS
AFC Asian Financial Crisis
AFL-CIO American Federation of Labor and Congress of Industrial Organizations
AIG American International Group
ANE arranged, negotiated, or executed
ASIFMA Asian Securities Industry and Financial Market Association
ASX Australian Securities Exchange
BCBS Basel Committee on Banking Supervision
BIS Bank for International Settlements
BRICS Brazil, Russia, India, China, and South Africa
CCP central counterparty
CDO collateralized debt obligation
CDS credit default swap
CEA Commodity Exchange Act
CEO Chief Executive Officer
CFMA Commodity Futures Modernization Act
CFTC Commodity Futures Trading Commission
CGFS Committee on the Global Financial System
CMC Commodity Markets Council
CME Chicago Mercantile Exchange
CMOC Commodity Markets Oversight Coalition
COU Central Operating Unit
CPMI Committee on Payments and Market Infrastructures
CPSS Committee on Payment and Settlement Systems
CRMPG Counterparty Risk Management Policy Group
CVA credit valuation adjustment
DCO derivatives clearing organization
Dodd-Frank Dodd-Frank Wall Street Reform and Consumer Protection Act
DTCC Depository Trust & Clearing Corporation
EMIR European Market Infrastructure Regulation
ESMA European Securities and Markets Authority
ETP electronic trading platform
FBOT Foreign Board of Trade
FRB Federal Reserve Board
FSB Financial Stability Board
FX foreign exchange
G14 largest fourteen derivatives dealers
G16 largest sixteen derivatives dealers
G20 Group of Twenty
G30 Group of Thirty
GDP gross domestic product
G- SIB global systemically important bank
HKEX Hong Kong Exchange
HKMA Hong Kong Monetary Authority
IATP Institute for Agriculture and Trade Policy
ICE Intercontinental Exchange
IIF Institute of International Finance
IMF International Monetary Fund
IOSCO International Organization of Securities Commissions
IPE international political economy
IRS interest rate swap
ISDA International Swaps and Derivatives Association
JFSA Japanese Financial Service Authority
JSCC Japan Securities Clearing Corporation
LCH London Clearinghouse
LEI legal entity identifier
LTCM Long Term Capital Management
MAS Monetary Authority of Singapore
MBS mortgage-backed security
MiFID II Revision of the Market in Financial Instruments Directive
MoU Memorandum of Understanding
MTF multilateral trading facility
NDF non-deliverable forward
NGO nongovernmental organization
NYMEX New York Mercantile Exchange
OCC Office of the Comptroller of the Currency
ODRF OTC Derivatives Regulators’ Forum
ODRG OTC Derivatives Regulators Group
ODWG OTC Derivatives Working Group
OFR Office for Financial Research
OTC over-the-counter
PFMI Principles for Financial Market Infrastructures
RCAP Regulatory Consistency Assessment Program
SDMA Swaps and Derivatives Market Association
SEC Securities and Exchange Commission
SEF swap execution facility
SFC Securities and Futures Commission
SGX Singapore Exchange
SIFMA Securities Industry and Financial Markets Association
SOMO Stichting Onderzoek Multinationale Ondernemingen (Centre for Research on Multinational Corporations)
SPV special purpose vehicle
SSB standard-setting body
TARP Troubled Asset Relief Program
TR trade repository
UCC Uniform Code Council
UTI unique trade identifier
VaR value-at-risk
WDM World Development Movement
WEED World Economy, Ecology and Development
WMBAA Wholesale Markets Brokers Association of America
CONTRIBUTORS
Matthew Gravelle recently completed his PhD in Political Science at the University of British Columbia in Vancouver, Canada.
Eric Helleiner is a Professor in the Department of Political Science and Balsillie School of International Affairs, University of Waterloo, Ontario, Canada.
Peter Knaack is a postdoctoral research fellow at the Blavatnik School of Government, University of Oxford.
Yu-wai Vic Li is an Assistant Professor in the Department of Social Sciences at the Education University of Hong Kong.
Erin Lockwood is an Assistant Professor in the Department of Political Science at the University of California, Irvine.
Stefano Pagliari is a Senior Lecturer in the Department of International Politics at City University of London.
Elliot Posner is an Associate Professor of Political Science at Case Western Reserve University, Cleveland, Ohio.
Irene Spagna is a PhD candidate in Global Governance/Global Political Economy at the University of Waterloo, Ontario, Canada.
Governing the World’s Biggest Market
Introduction Governing the World’s Biggest Market
The Politics of Derivatives Regulation after the 2008 Crisis
Eric Helleiner, Stefano Pagliari, and Irene Spagna
This book examines the politics of derivatives regulation after the 2008 global financial crisis. At the time of the crisis, derivatives had come to occupy a central position in the global economy. By the end of 2008, the notional value of outstanding over-the-counter (OTC) derivatives contracts totaled USD 684 trillion, a staggeringly large figure that was approximately ten times the global gross domestic product (GDP).1 Taken together, derivatives had in fact grown to be the world’s biggest market. This market involved participants from across the globe ranging from large banks and pension funds to farmers and manufacturers, from governments and municipalities to international financial institutions and sovereign wealth funds.
The 2008 financial crisis revealed very starkly that derivatives mattered not just to these groups participating in this huge market. The trading of these financial products—which include forwards, futures, options, or swaps—was also enormously significant to everyone else in the world. Before the crisis, star investor Warren Buffett had warned in 2002 that “derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”2 This warning proved prescient when derivatives contributed in significant ways to the severity of the 2008 meltdown.
1 OTC figures from Bank for International Settlements 2010: 6. OTC derivatives represented about 90% of all global derivatives at the time.
2 Buffett 2002: 15.
In the wake of the crisis, policymakers in the G20 jurisdictions committed to reform the regulation of derivatives markets.3 The regulation of derivatives was a topic that had previously not attracted much sustained public attention, despite the extremely rapid growth of the markets since the early 1980s. A few corporate scandals (e.g., Enron, Orange County) and episodes of financial instability involving derivatives (e.g., Long Term Capital Management) in the 1990s had briefly brought derivatives onto the agenda of regulators and scholars, but these episodes proved to be short-lived and failed to alter significantly the regulation of these markets.4 The situation changed with the financial crisis of 2008, as the regulation of derivatives markets now assumed center stage on the international public policy agenda and not just because of concerns about systemic financial instability. Critics argued that inadequate regulation of derivatives also contributed to commodity price volatility, sovereign and corporate debt problems, market abuse, and, more generally, the growing and unchecked influence of private financial interests. In short, derivatives markets were suddenly at the middle of core political debates about the distribution of power and wealth in the modern world economy.
What have been the precise goals of the G20 reform agenda? What have been the results of efforts to implement this agenda to date? More generally, what does this episode teach us about the politics of derivatives regulation after the global financial crisis? Despite the global importance of derivatives markets, these questions have not received much attention to date from those interested in the politics of the global economy. Even among those who specialize in the study of the politics of global financial regulation, other topics such as banking rules receive much more attention than the governance of derivatives. For many scholars and students of global political economy, derivatives markets remain mysterious and complex.
This volume is designed to begin to rectify this relative neglect. The first chapter by Irene Spagna provides some background for readers with less knowledge of derivatives by describing and analyzing the dramatic growth of pre-crisis derivatives and their contribution to the 2008 crisis. The rest of the chapters then address the questions we have raised by analyzing various aspects of the politics of post-2008 derivatives regulation. Some of these chapters focus on the dynamics of international regulatory coordination between leading powers, while others examine reforms in specific geographical contexts or with respect to specific issue areas. Despite these different foci, some common themes emerge
3 The G20 jurisdictions are: Argentina, Australia, Brazil, Canada, China, European Union, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, United Kingdom, and United States.
4 Tsingou 2006.
in addressing the three core questions. The purpose of this introductory chapter is to summarize these themes.
What Have Been the Goals of the G20 Regulatory Agenda?
The first theme concerns the content of the G20- led reform objectives themselves. As Irene Spagna explains in chapter 1, policymakers in the United States and other leading financial powers such as the United Kingdom had allowed derivatives to grow largely unchecked in the years leading up to the crisis, particularly OTC derivatives that are traded bilaterally and privately away from organized exchanges. They had done this not just through various liberalizing and permissive rules but also through their support for selfregulatory initiatives of market actors and private industry bodies such as the International Swaps and Derivatives Association (ISDA). The 2008 crisis ushered in an important change in official attitudes whose dimensions this volume explores.
The shift in attitudes was already apparent when the G20 leaders met for the first time in November 2008 to endorse a new international agenda for financial regulatory reform. In their final statement, the G20 leaders called for “a review of the scope of financial regulation, with a special emphasis on institutions, instruments, and markets that are currently unregulated” and OTC derivatives were specifically identified as a priority area.5 By the time of their third summit in September 2009 in Pittsburgh, the G20 leaders had settled on a new comprehensive set of regulatory goals for derivatives markets that they each agreed to implement.6
To begin with, the G20 leaders committed to force all standardized OTC derivatives contracts to be cleared by central counterparties (CCPs) by the end of 2012. CCPs are designed to act as an intermediary between sellers and buyers of derivatives, guaranteeing trades should either party default, and forcing both parties to post margin or collateral to cover potential losses. Officials argued that CCPs would reduce systemic risks by minimizing uncertainty in the markets and by enabling counterparty risks to be managed centrally and to be better supervised and regulated. CCPs were already used in some segments of the industry and the G20 leaders now committed to extend this practice for all standardized derivatives contracts on a mandatory basis.
5 G20 2008.
6 G20 2009.
The G20 leaders also declared that derivative contracts not centrally cleared should be subject to higher capital requirements, a move that both incentivized central clearing and mitigated the risks associated with non-standardized contracts that continued to be cleared bilaterally. In addition, they decided in 2011 to create common global standards for initial and variation margins for noncentrally cleared contracts in order to ensure that collateral was available to cushion the impact of defaults and to help address “de-stabilizing pro-cyclicality” that resulted from the tendency of market actors to lower margins in boom times and raise them in crises.7 These standards were then announced in 2013.8
Equally important, they committed to ensure that CCPs be subject to effective regulation and supervision—a particularly important aim given that derivativesrelated counterparty risks would now become increasingly concentrated in CCPs. International financial standard-setting bodies subsequently developed standards for CCPs that addressed issues such as prudential requirements, market access rules, measures to protect customer positions and assets, governance arrangements, information disclosure, as well as resolution and recovery.9
Another goal outlined by the G20 leaders in September 2009 was that, by the end of 2012, “all standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate.”10 By bringing bilateral OTC trades onto these organized trading platforms, policymakers sought to make them more transparent not just to regulators but also to other market participants. Greater transparency would help reduce the asymmetric control of information by the dealer banks that dominated these markets through their unique knowledge of trading prices and volumes. The markets would, it was hoped, thus become less prone to what the G20 called “market abuse” and would function more smoothly, particularly in times of stress.11
Another major objective outlined by the G20 leaders in September 2009 was that all OTC contracts—both cleared and non-cleared—should be reported to “trade repositories” (TRs). TRs serve as centralized registries collecting and maintaining records about who has traded what and with whom. One TR had already emerged before the crisis to reduce confirmation backlogs for credit default swaps (CDSs), a product whose purchasers pay a fee every quarter to the seller in return for a promise that the full value of an underlying bond will be repaid in the event of a default. Because CDSs ended up at the center of the 2008 crisis (for reasons explained in the next chapter), this TR was able to help calm
7 BCBS and IOSCO 2012: 2; see also G20 2011.
8 BCBS and IOSCO 2013.
9 CPSS and IOSCO 2012; IOSCO and CPMI 2014.
10 G20 2009.
11 Quote from G20 2009: 9. See also Financial Stability Board 2010: 10.
fears during the Lehman crisis by publicizing how the size of net CDS exposure was smaller than many expected at the time. By forcing all OTC derivatives contracts to be reported to TRs, the G20 leaders hoped to give market actors greater information, and regulators and supervisors a more complete picture of risk exposures across all markets.12 International regulatory bodies subsequently also developed standards for TRs that cover similar issues as those for CCPs and seek to ensure that regulatory authorities gain access to TR data and that global aggregation mechanisms are established.13
Alongside those various goals, the G20 leaders also announced one final objective in late 2011 that applied more specifically to commodity derivatives markets. During the financial crisis of 2008, commodity prices spiked dramatically in ways that contributed further to the global economic instability at the time. As Eric Helleiner details in his chapter, this experience and another set of price spikes in 2010‒11 generated much concern about whether growing speculative trading in commodity derivatives markets was contributing to commodity price volatility. Responding to this concern, the G20 leaders declared in late 2011 that regulators of commodity derivatives markets “should have, and use formal position management powers, including the power to set ex-ante position limits.”14 Many countries already had in place “position management powers”—such as position limits that set ceilings on the number of contracts each trader could hold in specific markets—but this statement signaled a new international endorsement and encouragement of their use.
Taken together, these core goals outlined by the G20 leaders (and summarized in table I.1) were heralded as a historic departure from the pre-crisis regulatory paradigm. They did indeed signal a new willingness to strengthen public regulation and supervision of global derivatives markets. At the same time, this volume argues that it is important not to overstate the degree of change from pre-crisis norms that is embodied in the G20 reform agenda.
The Limits of Change
One reason to be cautious is that the G20 leaders continued to assign profitseeking private actors a prominent place in the governance of derivative markets. Many of the institutions placed at the center of the reforms—CCPs, exchanges, and TRs—were of this kind. In the important case of CCPs, the Bank of England initially warned against this strategy, arguing that a nonprofit, user-owned governance structure would be optimal because these institutions were now being
