BY ELENA VERNIKOV
Both Dodd Frank (DF) and European Markets Infrastructure Reform (EMIR) were implemented after the world financial crisis in 2008 and were part of the financial regulatory reforms intended to regulate the market and reduce the risk of derivatives trading in the United States and the European Union. Switzerland’s most important trading partners, over 80% of all trade, are within the EU. On June 19th 2015 the Swiss Parliament approved the Swiss answer to EMIR and Dodd Frank – the Swiss Financial Markets Infrastructure Act (“FMIA”, in German also known as “FinfraG”). Switzerland had no choice but to implement its own regulation – it was necessary in order to have equal terms and successful trading with both EU and US. The purpose of this regulation was to align the Swiss regulatory structure with the international standards alongside Dodd Frank and EMIR.
FinfraG applies a number of obligations not only for Swiss market participants and their counterparties, but also spreads liabilities to foreign branches of banks and to other legal entities if they trade derivatives with Swiss companies. Over the counter (OTC) and exchange traded derivatives transactions fall in scope of this regulation, however, there are certain exemptions to take into account. The Swiss Federation, the municipalities, the Swiss National Bank and the Bank for International Settlement will not be in scope of the FinfraG regulation.
The four fundamental obligations that may apply to the company under FinfraG, depending on the classification of the party and the derivative product they are trading, are consistent with the commitment the G20 made at the 2009 Pittsburgh summit and the subsequent requirements both the US via the Dodd Frank Act and the EU via EMIR enacted into law:
- Reporting obligation
The OTC and exchange trading derivatives transactions should be reported to a trade repository recognized or authorized by FINMA (Swiss Financial Market Supervisory Authority). This obligation is “single sided”, where only one party should be reporting the transaction. For each trade, the party should provide important detailed information such as the identity, type of trade, maturity, nominal value, price, settlement date and currency.
- Mandatory clearing obligation
Clearing is a process between the conclusion and settlement of a trade. Obligation includes OTC derivatives transactions, which should be cleared through recognized or authorized by FINMA Central Clearing Counterparty. The participants have to organize the clearing process and enter into a clearing agreement to comply with this Rule.
- Risk mitigation (valuation of trades, operational risk, exchange of collateral)
All counterparties are responsible for confirming trade obligations in a timely manner, controlling the related risks, marking the value of non-cleared OTC derivatives and exchanging appropriate collateral. OTC derivatives that did not go through the clearing process will be subject to this obligation.
- Platform trading obligation
Given that both parties are large entities, OTC derivatives have to be traded over an authorized and recognized platform.
The regulation distinguishes between two types of entities: financial counterparties (FC), which are financially involved in markets (e.g., banks, insurance companies, funds) and non-financial counterparties (NFC), which are all other entities. Both financial and non-financial counterparties divide into larger entities (FC+), (NFC+) and smaller entities (FC-), (NFC-). Smaller entities have fewer obligations under the regulation. FinfraG affects all participants, but the level of impact will vary based on the size and type of entity.
To comply with FinfraG, participants have to first determine the exposure to the regulation and its impact on the company. Participants also have to implement multiple processes and adapt a number of legal contracts. It is crucial for each company to determine how they are classified and to update this information on a regular basis.
In conclusion, FinfraG aims to ensure there is proper functioning and transparency of the securities and derivatives markets, the protection of financial market participants and equal treatment of the investors. The fundamental obligations of the new regulation are consistent with the US and the EU, and will help to regulate derivative transactions in Switzerland, positively impacting the stability of the Swiss financial system. Moreover, given that rules and regulations are constantly evolving, FinFraG is only the first step taken by Switzerland, likely to be followed by more regulations to combat future market risk and create economic stability.