Testimony of Scott O’Malia
Chief Executive Officer
International Swaps and Derivatives Association

Before the US House of Representatives
Committee on Agriculture
Subcommittee on Commodity Exchanges, Energy, and Credit

April 28, 2016

Chairman Scott, Ranking Member Scott and Members of the Subcommittee. Thank you for the opportunity to testify today.

I would like to thank the Committee for holding this timely hearing to discuss the ramifications of the last two rule-sets associated with the Group of 20 (G-20) derivatives reforms – bank capital and liquidity rules, and margin requirements for non-cleared derivatives trades. Both will have a profound impact on derivatives end users.

The capital and liquidity rules, which are being developed by the Basel Committee on Banking Supervision, will be implemented through to 2019. The margin rules kick in from September this year, and will be fully phased in by 2020.

My testimony today will address these two important rules. I will explain the findings ISDA and its members have produced to determine the cost impact of individual capital rules, and will emphasize the need for a comprehensive cumulative impact assessment encompassing all elements of the bank capital and liquidity reforms. I will also provide a progress update on the implementation of the margin rules, and the steps ISDA is taking to help regulators and market participants comply with them in a cost-effective and transparent manner.

Executive Summary

Over the past six years, substantial progress has been made to ensure the financial system is more robust. The implementation of the Basel 2.5 and Basel III capital and liquidity reforms means that banks now hold more and better quality capital than ever before. The amount of common equity capital at the largest US banks has more than doubled since the crisis. Liquidity requirements are also being phased in to reduce reliance on short-term borrowing and bolster reserves of high-quality liquid assets.

This is on top of derivatives market structure reforms that have been introduced by the Commodity Futures Trading Commission (CFTC) and, to some extent, the Securities and Exchange Commission (SEC), which include swap dealer registration, data reporting, trading and clearing mandates. In addition, a resolution framework is now being put in place to manage and allow for the orderly resolution of a bank without the need for taxpayer assistance.

But while many aspects of the new rules have been finalized and are already implemented, core elements of the Basel reform agenda, such as the leverage ratio, net stable funding ratio (NSFR) and the Fundamental Review of the Trading Book (FRTB), are still evolving.

As it stands, these reforms look set to significantly increase costs for banks, and may negatively impact the liquidity of derivatives markets and the ability of banks to lend and provide crucial hedging products to corporate end users, pension funds and asset managers.

We are concerned that the overall effect of the different parts of the bank capital reform program is unknown, and it is our belief that regulators should undertake a cumulative impact assessment post haste. When it comes to the health of the global financial system and economy, I think the old tailor’s saying holds true – measure twice, cut once.

At the moment, we are cutting our cloth in the dark. Given continuing concerns about economic growth and job creation, legislators, supervisors and market participants need to understand the cumulative effect of the regulatory changes before they are fully implemented so we can prevent any significant negative impact to the real economy.

ISDA has been working hard to understand the impact of the individual elements of the rules. Over the past year, we have conducted eight impact studies on new capital and liquidity measures. In each case, those studies have indicated sizeable increases in capital or funding requirements for banks, on top of the increases that have already occurred as part of Basel III.

There is literally no one who has any clear idea what the aggregate impact of each of these rules will be. So far, each new measure has been looked at in isolation, without considering how it will interact with other parts of the capital framework.

Significantly, ISDA’s analysis shows the impact is not uniform across all banks, with certain business lines hit particularly hard. We therefore believe it is crucial that policy-makers not only view the final capital rules through the prism of the overall impact on capital levels, but also assess the effect on individual business lines.

That’s because the impact of the new rules on individual business units or product areas could be disproportionate, and the difference between a bank choosing to stay the course or exit the business. One good example is the leverage ratio and its effect on client clearing businesses. As it stands, the rule fails to recognize the risk-reducing effect of initial margin posted by the customer. This has proved detrimental to the economics of client clearing and is in direct conflict with the G-20 goals to encourage central clearing of derivatives.

Having provided my high-level recommendations on the capital and liquidity rules, I’d now like to turn to the final rules regarding margin for non-cleared derivatives. 


As I noted earlier, these rules will have a significant cost impact on non-cleared derivatives trades. According to analysis published by the Federal Reserve and the CFTC, the industry may have to set aside over $300 billion in initial margin to meet the requirements.

ISDA has worked closely with the market at a global level to prepare for implementation. I am proud to say ISDA and its members have accomplished a great deal.

First, we have developed a standard initial margin model called the ISDA SIMM that all participants can use to calculate initial margin requirements. In a bilateral setting, having a central resource that can do this and resolve any disputes over initial margin calls will be vitally useful for all counterparties.

Second, we’ve worked to draw up revised margin documentation that is compliant with the rules, and we’re developing a protocol to allow market participants to make changes to their outstanding margin agreements as efficiently as possible. This is essential for all market participants to exchange margin in an orderly and legally compliant way.

Third, we have established a completely transparent and robust governance structure to allow for the necessary evolution of the model, providing both regulators and market participants the confidence that the model is appropriately updated and available for regulatory review and validation.

Despite these efforts, challenges remain. In particular, there are concerns about how the margin rules will work on a cross-border basis. The requirements were drawn up at a global level by the Basel Committee and the International Organization of Securities Commissions (IOSCO) before being implemented by national regulators. That’s a process we support, and has meant the various national rules are largely consistent.

But differences do exist in the detail, in everything from scope of the products and entities covered by the rules to settlement times. This means it is vital that substituted compliance decisions are based on broad outcomes, rather than rule-by-rule comparisons with overseas requirements.

The deadline for implementation of the initial margin requirements for the largest banks (Phase I) is approaching on September 1, 2016. Following this date is the variation margin ‘big bang’ on March 1, 2017, which affects all market participants.

There are a few items that need to fall into place to ensure the market can move forward confidently with these last rules.

First, regulators need to send a clear signal that the ISDA SIMM is fit for purpose and banks can confidently begin to apply this model to comply with the September 2016 deadline.

Second, the CFTC must finalize its cross-border margin rules to ensure substituted compliance determinations can be made for overseas rules that achieve similar outcomes.