ISDA, the International Swaps and Derivatives Association, has told the UK government it has concerns that the draft bank ring-fencing legislation is “overly restrictive” and creates “artificial distinctions” which will not achieve the stated policy objectives.
In a letter sent to the UK Treasury in response to a consultation document, ISDA says that the approach of allowing ring-fenced banks (RFBs) only to sell “simple” derivatives – hedging interest rates, foreign exchange and commodity risk – may make the provisions “more complex to implement, apply and enforce”, while preventing RFBs from entering into other derivatives “which are intrinsically no less simple”.
Moreover, ISDA adds that there is no clear reason why an RFB would only be allowed to offer such simple derivatives to “account holders” – defined in the legislation as someone who has a current account or deposit account with an RFB (other than another financial institution).
“This would mean that the RFB would not be able to enter into simple derivatives with any of its other customers… for example, if a customer has borrowed from the RFB, but does not have a current or deposit account,” ISDA said.
Language “not meaningful”
ISDA’s submission explains that the legislation uses terminology that is “not meaningful” when it refers to “selling” an OTC derivative instrument. “A person entering into an OTC derivative instrument will create that OTC derivative instrument by contract,” USDA said. “With limited exceptions it is not meaningful to refer to "selling" an OTC derivative instrument.
The draft law restricts RFBs to a derivative which “relates to” currencies, interest rates, or commodities. But bond futures are, ISDA said, often categorised as interest rate derivatives and yet these could be interpreted as being outside the scope of the definition of “simple derivatives” because “the underlying [asset] of the relevant derivative is a bond”.
In the government’s consultation it asks for views on restricting RFB derivatives contracts to forward, future and swaps contracts. ISDA responded that it was not clear from the language of the legislation that swaps would, in fact, be within scope because the requirement appears to be that the profit or loss be “directly proportional” to a change in the value of the reference instrument.
Nor does ISDA believe it is appropriate to exclude options: “It is equally possible to create a complex swap contract as it is to create a simple option,” ISDA wrote. “This provision should focus on whether or not the relevant contract is a "simple" derivative, rather than seeking to identify particular types of contract as intrinsically complex.”
ISDA’s letter to HM Treasury – as well as a letter from the Joint Associations Committee on Retail Structured Products – can be downloaded here.