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An analysis of the proposed regulatory reforms for derivatives trading in Canada Barta, Winston Victor

Abstract

Since the global financial crisis of 2008, policy makers have been working to develop laws that will increase the financial systems’ transparency and resiliency while maintaining fairness and efficiency. At the heart of the market infrastructure reform initiatives are measures aimed squarely at the regulation of derivatives. This paper aims to provide a high level review of some of the new Canadian legislation targeting derivatives. It examines the motivations for regulating the use of these sophisticated financial products as well as the complexity of legislating within a country whose securities laws have long been managed at the provincial level. The paper offers suggestions on the important features and direction of the law in this area. The analysis leads to several conclusions regarding the developing legislation. Central counterparty clearing and margin requirements are important regulatory initiatives to mitigate counterparty credit risk, being the key way in which derivatives contribute to systemic risk. Central clearing, however, cannot be relied upon as the primary guard against the spread of systemic risk by derivatives markets. This responsibility should remain in the hands of vigilant regulators. This leads to the key conclusion, being the need for effective management, at the national level, of the systemic risk created by derivatives markets. A robust national regulator would not only have access to real-time trade reporting data but would also monitor movements within defined sectors, like housing for example, to be alert to any risk accumulation within an overheated market. In addition, the analysis concludes that the use of investor sophistication as a regulatory trigger, as currently part of the proposed market conduct rules, is a valuable delimiter of differing levels of required disclosure. The research also concludes that investor sophistication could be a valuable tool to manage the nexus of sophisticated derivatives products entering the retail economy by potentially limiting their availability based on a combination of product complexity and investor sophistication.

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Attribution-NonCommercial-NoDerivatives 4.0 International

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