Canada's regulators say they're "satisfied" with the pace of reform in the global derivatives business. They must be happy watching snail races and paint-drying exhibitions, too.
This week, Canada's main financial authorities – the Bank of Canada, the Canadian Securities Administrators, the Office of the Superintendent of Financial Institutions and the federal Department of Finance – issued a statement updating Canadian and international efforts to install a better, less risky, more transparent system for clearing standardized over-the-counter (OTC) derivatives contracts.
This is a huge issue in the world of securities regulation. OTC derivatives are used by financial institutions, fund managers and a wide variety of other investors to place bets on, or hedge against, movements in everything from commodity prices to exchange rates to interest rates. The gross market value of these securities topped $27-trillion as of the end of last year. Derivatives trading played a major role in the global financial meltdown of 2008. The woeful lack of transparency in the market caused trading to seize up because no one was sure which institution was exposed to what risks. This week's statement said Canada remains committed to the reforms initiated by the G20 leaders in 2009. Central to those reforms was the notion that the world should set up a group of recognized central counter parties, or CCPs, that can stand behind OTC derivative trading and reduce the risk of one defaulting institution setting off a cascade of problems. According to the statement, Canadian authorities are content with the pace at which reform is moving.
Hidden between the lines of the cryptic statement was the new information that Canadian authorities have dropped their preference for a made-in-Canada clearing system. They're now okay with Canadian institutions doing deals through recognized foreign CCPs that meet Canadian regulatory standards for safeguarding the market against abuses – although that won't preclude anyone from creating Canadian-based CCPs, too.
Why are Canadian officials saying this now? Because the G20, at its Pittsburgh summit in September, 2009, made a commitment: "All standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counter parties by end-2012 at the latest [my italics]."
It's certainly helpful that Canadian authorities have made this key decision on how they want to proceed with a derivatives clearing system. But let's be crystal clear: This week's statement doesn't get us anywhere near having the new derivatives framework in place by the end of the year. We're still months short of incorporating these vital changes into Canada's securities regulations, let alone actually implementing them.
The clearing system represents just one of the eight key issues surrounding the derivatives policy that the CSA has identified. It has issued consultation papers on five of them; three more papers are still to come. Once a consultation paper is issued, it's put out for public comment for 90 days. Then it comes back to the regulators, who draw up a formal set of "draft" rules. Those, too, go out for public comment for another 60 days. Add a month or so for regulators to clean up the draft document and produce a final document, and then it's off to each province's Finance department for ministerial approval – which takes even more time.
Add it all up, and multiply by eight sets of documents? It's a decent bet that we'll still be waiting for implementation this time next year. And Canada isn't by any means the lone laggard. Most of the G20 will miss the deadline.
In June, the global Financial Stability Board (FSB) published its third progress report since the G20 agreement. The best it could say is that the world's three biggest derivatives markets – the European Union, the U.S. and Japan – are closer than everyone else on getting their ducks in a row, and all three "expect to have regulatory frameworks in place by end-2012."
Yet the EU admitted in May that there was no way it would make the year-end deadline. At best, officials said, it would have all the legislation in place. Meanwhile, the FSB as much as scolded many other countries for lagging on their own national frameworks, as they waited for the big markets to nail down their reforms first.
For investors who saw economies melt away in the murky depths of a runaway derivatives market, this is discouraging. Four years since the financial crisis, three years since the world decided to do something about it, we're still operating in a risk-riddled financial system without the needed safeguards in place.