WFE letter to FSB on capital standards for ETDs

Mark Carney

Chairman, Financial Stability Board (FSB)


Stefan Ingves

Chairman, Basel Committee on Banking Supervision (BCBS)


William Dudley

Chairman, Committee on the Global Financial System (CGFS)


Paul Tucker

Chairman, Committee on Payment and Settlement Systems (CPSS)


Masamichi Kono

Chairman, IOSCO Technical Committee


RE:     Advancing the G20 OTC Market Reforms by Correcting Inconsistencies in Derivative Margin Frameworks to Reflect Liquidity and Efficiency of Exchange Traded Derivative Markets


Dear Sirs:

The World Federation of Exchanges (WFE) is the global association representing the interests of 59 publicly regulated stock, futures, and options exchanges, as well as the central clearing houses that many of these exchanges operate.  Collectively, WFE members represent the vast majority of the global exchange-traded equities and derivatives markets.  The International Options Markets Association (IOMA) is the WFE’s global association of options and futures exchange leaders.  The member list of WFE is included in the annex to this letter.

During and immediately following the global financial crisis in 2008, the WFE vigorously advocated for reform and regulation of the OTC derivatives markets, which were identified as having made significant contributions to financial turmoil.  WFE applauded the OTC reform commitments made by the G20 Finance Ministers at their November 2009 meeting in Pittsburgh.  In support of the G20 commitments to increase transparency in derivative markets and to promote central clearing, our associations and members have continually engaged with global standard setters as well as national and regional policymaking bodies to implement regulatory reforms and address gaps and redundancies in national approaches and global frameworks.  

With respect to risk management and margin standards, the WFE encourages the Financial Stability Board (FSB) to ensure that inconsistencies in the international guidelines in relation to exchange traded derivative (ETD) margin standards and banking regulatory capital standards do not undermine the G20 commitments of moving standardized derivatives to central clearing and, when appropriate, to highly transparent trading platforms such as the regulated exchanges operated by WFE members.  

Specifically, we ask that the FSB coordinate and collaborate with the Basel Committee on Banking Supervision (BCBS), the Committee on the Global Financial System (CGFS), the Committee on Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissioners (IOSCO) to resolve differences between the initial margin approach set out in the CPSS-IOSCO Principles for Financial Market Infrastructure (PFMIs)  (and reflected in some national regulatory rules or proposals for ETDs) and the conflicting Basel Committee on Banking Supervision (BCBS) Interim Capital Framework.                        

The Interim Capital Framework referred to above seeks to apply a blanket 5-day margin period of risk standard to highly liquid and transparent ETDs.  The CPSS-IOSCO PFMIs appropriately distinguish between the risk profiles of ETDs and cleared OTC products.[1]  CPSS-IOSCO PFMI’s are reflected in regional and national margin and risk management regulatory frameworks around the world.  These margin frameworks recognize the deep liquidity, transparent pricing, significant turnover rates, and overall efficiency of most ETDs relative to OTC derivatives and, in some cases, apply a 1 to 2-day margin period at risk standard for ETDs.[2]

The significant liquidity and turnover advantages of ETD markets are confirmed by a recent study commissioned by the WFE and completed by the TABB Group which estimates that there are approximately 9,800 OTC trades per day across all OTC asset classes contrasted with nearly 6.2 million trades per day in global interest rate futures market alone.  This equates to a 630 times greater turnover rate for exchange traded interest rate contracts compared to the turnover rate of all of the asset classes that make up the OTC derivatives market.[3]  Due to their significant liquidity and turnover advantages as well as the extensive availability of pricing data, ETDs are usually efficiently liquidated and generally pose less risk than privately negotiated, customized, and less frequently traded OTC derivatives. 

If adopted by the BCBS and implemented by national bank regulators, the static 5-day margin period of risk standard will not only be in conflict with the CPSS-IOSCO PFMIs but also have the effect of increasing costs for client users of ETDs. [4]  This may force exchange users (e.g. manufacturers, food producers, employee pension funds, and investors) to either discontinue critical hedging practices or move activity to the less transparent OTC derivative markets.  Such outcomes would clearly undermine the G20 OTC market reform commitments. 

The WFE respectfully requests global standard setters to eliminate the 5-day margin period of risk banking capital standard for exchange traded derivatives and demonstrate international support for the more appropriate 1 to 2-day standard for the highly liquid, transparent, and efficient exchange traded derivative markets.  This standard should apply across all methods permitted under the Basel framework to compute counterparty credit risk exposure for ETDs. Such action by global standard setters will be instrumental in advancing the G20’s commitment to bring increased transparency and the safety and soundness of central clearing to the global derivatives market and broader financial system.

As the global associations for exchanges and clearing houses, the WFE and IOMA appreciate your consideration and stand ready to lend our members’ collective expertise to this critical discussion.

Cordially yours,

Huseyin Erkan

Chief Executive Officer, Word Federation of Exchanges


Jorge Alegria

Chairman, IOMA

[1] CPSS-IOSCO Principles for Financial Market Infrastructure. “When setting margin requirements, a CCP should have a margin system that establishes margin levels commensurate with the risks and particular attributes of each product, portfolio, and market it serves. Product risk characteristics can include, but are not limited to, price volatility and correlation, non-linear price characteristics, jump-to-default risk, market liquidity, possible liquidation procedures (for example, tender by or commission to market-makers), and correlation between price and position such as wrong-way risk.  Margin requirements need to account for the complexity of the underlying instruments and the availability of timely, high-quality pricing data. For example, OTC derivatives require more-conservative margin models because of their complexity and the greater uncertainty of the reliability of price quotes” (Explanatory Note 3.6.3).  “A CCP should adopt initial margin models and parameters that are risk-based and generate margin requirements that are sufficient to cover its potential future exposures to participants in the interval between the last margin collection and the close out of positions following a participant default. Initial margin should meet an established single-tailed confidence level of at least 99 percent with respect to the estimated distribution of future exposure.” (V. Appendix 3.6.6).

[2] ESMA 2012/600 Draft technical standards under the Regulation (EU) no 648/2012 of the EP and of the EC on OTC Derivatives, CCP’s and TR’s / Art. 26 no 1 and 4 Title: 17 CFR Parts 1, 21, 39 and 140 Derivatives Clearing Organization General Provisions and Core Principles. U.S. Federal Register Citation: 76 FR 69334 (11/8/2011). 

[3] TABB estimates that there are 4300 trade per minute in the global interest rate futures markets which equals an average of 6,192,000 trades in a 24 hour period.  TABB estimates that 6.8 trades per minute occur in the entire OTC market which equals 9,792 trades in a 24 hour period. See pages 40-41: The New Global Risk Transfer Market: Transformation and the Status Quo, TABB Group, August 2012.

[4]The Interim Capital Framework establishes capital requirements for banks’ exposures to CCPs and to clients for whom they perform clearing services as direct clearing members of CCPs.  There are two drivers that will result in higher capital requirements for ETDs, or prompt a significant increase in collateralisation requirements established by banks offering clearing services:  1)The Interim Capital Framework will require clearing members to hold capital equivalent to a 5-day margin period of risk (MPOR) for all client “cleared derivative” positions.  Under the prior capital framework, products that demonstrated certain characteristics such as those exhibited by cleared ETDs were afforded capital treatment that matched the risk of the product; and 2) The Interim Capital Framework allows clearing members to offset this 5-day capital requirement with the margin held against the client positions.[4]  Under the PFMIs and related national derivatives laws, cleared ETDs typically carry a 1-day or 2-day margin requirement versus the 5-day margin requirement assigned to cleared OTC products.[4]  This offset results in a 4-day or 3-day capital charge for ETDs versus 0-day charge for cleared OTC.  BCBS, Capital Requirements for Bank Exposures to Central Counterparties, July 2012 (BCBS 227)



Report Date: 
Tue, 11/27/2012