Overview
Scott O’Malia, CEO at ISDA returns for a ‘threepeat’, his 3rd time on the podcast. He joins John Pucciarelli, Head of Industry Engagement for this special episode of Ahead of the Curve. Their discussion ranges from the benefits and adoption of the Common Domain Model (CDM) across the industry, reflections on the advocacy and impact of the latest capital reforms including Basel III end game. Scott and John also discuss the latest regions to adopt Uncleared Margin Rules in 2024, and the role that ISDA plays in ensuring industry standards are maintained globally. The interview ends with Scott’s views on geopolitical risk and its potential impacts on the OTC derivatives market– it is a podcast not to be missed!
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Welcome, dear listeners, to another episodeof Acadia's Ahead of the Curve. I am your host, John Pucciarelli.Here with me today is a very special guest, CEOof ISDA, Scott O'Malia. Scott, welcome. -Thank you for having me again.Yes, this is a three-peat for you. -It's fantastic.It's unprecedented. -Great to be back.Happy to talk about all the big issues facing the derivative industry.We got a lot to unpack. We call this unpacking the agenda.The first time you did it. The second time we did it.We're going to continue on with it. We do have a lot to talk about.It's great to have you. This is the first time I'm actuallyin this studio. It's the first time we've done this podcastin a room together. It's quite nice, I like it.Yes, first class. -It is. Before we get into the agenda,how are things? I know there's a lot going on in the UK.You got the Euro Cup. You've got an election coming.I know there are a ton of things that ISDA has been doing.The last time I saw you was at the ISDA AGM in Tokyo.First of all, the AGM, I loved it, by the way.There is always a lot of work that goes on behind the scenes.What are some of the things that stood out to youat the AGM this year? -It was a well-attended AGM.We were in Tokyo this year. Cherry Blossoms waited till we got there.It was beautiful weather to be in Tokyo at that time,and there were great topics and issues on the agenda.We were talking about a lot of the things that we'll cover today.We were talking about the implementation of the margin rules,making sure we get the capital rules dialed in a risk-appropriate way.We're thinking about technology and innovation,how we can solve the problems that the industry faces in termsof operational challenges at all levels, supporting compliance,and doing so in the most cost-effective way.ISDA can play a serious role there. We also talked about someof our new initiatives around the notices hubthat we're going to be rolling out, as well as other technology solutions.When we unpack the agenda, I'm sure we'll get into it today,and I look forward to the conversation. -We absolutely will.We are going to touch on some of those things.The first thing that I wanted to talk to you aboutwas the Common Domain Model, or CDM. It is near to my heart as well.I don't know if everyone listening knows we were former colleagues.I worked at ISDA for five years. CDM was just kind of beginningwhen I was there. I don't know if it was 2015or something like that, right? There have been some recent wins for CDM.I know the work is never done. There are a lot of thingsthat we're working on at Acadia with you guys on in CDMand some use cases. Not everyone knows what CDM is.Can you just give us a brief, like what CDM is?Why is it important? Then you could talk about someof the recent wins that ISDA has had in this space.It starts with the regulatory agenda. Once the regulations were implemented,we had trading requirements, clearing requirements,data reporting, and non-clear margin requirements.All of these new requirements for the swaps and derivatives industryrequire a common infrastructure. Building that common infrastructurethat all participants were going to have to hook intoand align with to make sure that their compliance was donemade a lot of sense. Making sure that we were connectedto clearinghouses like LCH, trade repositories,and trade execution facilities. What had been done beforewas a bilateral relationship, so we did not have allof this standardization that was required. People hold data in different formats,and then they were required to report it in a common format.When we kind of went back and asked the membership,"What would be the most helpful solution for you?"They said, "Well, let's agree on common data formats,common taxonomy so we can start to map these common infrastructuresin a structured, consistent way. If you can do allof the post-trade infrastructure along those lines,it'll be much easier to scale and to automate."We said, "All right, fantastic. Where do we start?"It actually started with, how do you describe lifecycle eventsfrom the initiation of the trade all the way through data reportingand all the bits in between? What it came down tois you needed that foundation. It's not unlike what we do with legal,right? Get those legal terms right. Get the documentation squared away.Everybody's working off the same set of documentationto facilitate negotiation and trading. That's where we started.The common domain model is that common taxonomythat you describe lifecycle events across all productsin a very consistent way. Then you can use that to scale.We have an architecture for software. Then we license that,and it's actually not even licensed. It's open source.We give it to all of our members so that they can helpiterate and develop it, and we build that out across all products.We're now working with other trade associations,including ISLA, the Securities Lending, ICMA,the capital markets, which have the repo markets.They are also building the common domain modelto standardize their lifecycle events. Working together,we can bring scale and automation across the globe to help bring costs down.That's the goal. Make sure you comply exactlyas the regs require and do so in the most efficient way.That's what our objective is, and that's how the common domain is.It's a natural transition right from where we werewhen the regs were coming out, whether it was trade reporting, EMR.Now, as we settle into it and we see what the cost structures are,that's everyone's theme, right? Now, we're in an environmentof how do we save money? How do we reduce costs?We do the same thing. I think building adapterson the software side is costly. It's costly for everyone.If we can reduce that by using a common domain model,it's a win-win for everybody. Without letting things go publicly,there are quite a few use cases that Acadiais working directly with ISTA on. I'm excited about it.Between the end of this year or beginning of next year,we'll see how that all rolls out. Between collateralbetween trade reporting, I think the trade reporting piecemade a lot of sense. Even from a legal agreement perspective,it makes a ton of sense. -It touched on the trade reporting,which is probably our number one use case, and we're helping members comply today.We began with the CFTC. We've done Europe in a mere rules JFA,the Japanese rules. We have about another six rulesthat are left to be implemented in terms of data reporting.The regulators around the world have agreed to update their rulesto get better alignment, but they're not perfect.We make sure that we have the best practicesfor each jurisdiction. Then we code that using the common domain model,so that becomes your compliance tool. Probably, by the end of 25 or early26, we're going to have nearly a dozen jurisdictionsthat have the best practice and the common domain model.What the industry can count on from ISDA is our commitmentthat we will continue to update those core jurisdictions.The compliance tools will be pushed out using the common domain model.If you're using the common domain model, you will get complianceevery time there's an update. Again, that's a scale playthat we support as an industry trade association,and we push that down to our membership so your compliancebecomes much more cost-efficient. You don't have to do it all by yourself.You can rely on a consistent outcome that is regulatory compliant,and we're paying for it. At the end of the day,it makes everybody's life a lot easier. We like the opportunity around collateral.Everybody's exchanging collateral today, cleared and non-cleared.How do we standardize and automate that process?It is super efficient, cost-effective, and you get it done appropriatelybecause embedded in that is also a risk issue.LCH, Acadia, you guys deal with that on a regular basis.All the time. -The collateral reformis an exciting new opportunity that we all have to get better at.Yes, I agree. Look, it's the right thing to do.It's great that it's been gaining momentum.It's great that other trade associations have been getting on board.[inaudible 00:08:53-00:08:54] is involved. I think they had an event yesterdayhere in London. I think for all of us, getting behind something like thishas always been a great idea. It's great that it's coming to fruition.There's a lot more to come, I think. I'm really excited about it.Great. Thanks, Scott. Switching gears, talking about the AGM,capital reforms have always been on the agenda.In America, what's going on with the endgame?The advocacy and the impact, the Basel III endgamehad maybe 500 responses. I think one percent of itwas positive, right? It's an interesting space for usas well in Acadia, as we look at optimization and soccerand FRTB and all these other things that we offer our clientsin terms of optimization for capital. I did want to talk about thisbecause I know ISDA has done quite a bit in this space.Working with other trade associations, doing quantitative impact studies.Can you just touch on what's going on recently from an ISDA perspectiveon Basel III? I'm not going to ask you, like,where do you think it's going? Although we heard public commentsfrom Governor Bowman yesterday on the Federal Register.It looks like it's going to go in a positive direction.However, you look at that. Talk to me about your perspectives on thisand maybe what's next for ISDA, if anything?The Basel rules are very important, all the capital rules.ISDA has contributed through the entire Basel III processto the QIS consultations run by Basel and now run by individual jurisdictions.Throughout the process, we've helped refine and pushedfor risk-appropriate capital rules. The US Basel endgame,we're waiting for a final rule, but we've commentedon the interim rule or the draft rule. It has some serious problems.We committed focus specifically on the trading book.There's a banking book, the OP's book, and we're focused on the trading book.You mentioned the QIS, which we were able to respondto using the data provided by the G-SIBs banks,and that was useful. We were able to really look at itin a granular level. Our comment file was 163 pages.Data-driven, fact-based, and really got into the detailsand suggested very specific reforms. Let me just give you an exampleof three areas where we think there are some real problemsin the trading book. FRTB you mentioned.We think that there's about a 100 percent increase in RWAas a result of the proposal. A lot of that is drivenby the move to standardize approach. If internal modelsare not going to be used anymore, that's going to give youa more conservative implementation. A 100 percent increase in RWAis a huge lift. This is supposed to be kind revenuea neutral approach. You kind of wonder where that's coming from.Another area where we think they've overshot the markis on securities financing transactions. It is a Basel reform.There's an 18 percent increase in RWA, and that is due to a minimum floor.These are relatively low-risk assets, these security financing.It's critical to the financing of the derivatives,including supporting the collateral exchange.That's kind of important. It's got an 18 percent tax on it now.The Europeans ignored this proposal. It is not in the European approach.We think aligning those approaches is probably the better way to go,particularly for a low-risk trade. Then the final one,which I just find kind of unbelievable, is the 80 percent increase in clearing.Clearing has performed remarkably well post-crisis.Most of the derivatives today are in a clearing house.It has been cost-effective. It has been capital efficient.They're not proposing an increase on the client legof increasing by 80 percent through both the CVA proposaland the G-SIBs surcharge. With more things going into clearing,which is safer, I struggle to see why more capitalis going to make this process better. It is going to make it significantlymore expensive, which I think is the wrong way to do it here.Capital is super efficient today, we want to keep it that wayso people can continue to clear their trades.We really hope that they look more holisticallyat where we are in the clearing space and how the capital rulesare going to impact that, because it's a massive tax on clearing,and that's the wrong thing to do. -You laid it out, and like you said,it's fact-based, it's data-driven. We're not making these things up.It sounds like people are listening. It might be going in a directionthat makes sense. I'll put it that way.I guess more to come here. As of the taping of this,it's the end of June. I was worried that somethingwas going to come out this morning, and then we would have to shiftand talk about it but we're good. Maybe it'll come out next week, we'll see.The amount of work that ISDA has done, that the industry has done,these are big things. These are important things.It's great that this data is here and that you were able to articulate itand show it to everyone who needs to see it.It's not just our industry, it's everywhere, right?Those comments came from all sectors of the economy.This is an interesting space for me. We've been talking about thison our podcast as well. Thank you for sharing that with us, Scott,and more to come, I guess. Shifting gears a little bit awayfrom capital and looking really at some jurisdictionsthat ISDA has been focused on, Acadia has been focusedon as well as China, India and Mexico for several different reasons.I know from an ISDA perspective, you've been pouring a lot of resourcesand effort into closeout netting and getting that done in someof those jurisdictions in China and India specifically,but there's also UMR coming for India and Mexico.I'll talk a little bit about what Acadia is doing.Mexico's UMR is the end of this year, December 31st.I think India is on November 8th or something.I forgot the exact date. UMR just never ends.There's always something coming. I know ISDA has done quite a bit of workon all of those fronts. We continue to do that.What are some of the focuses on these markets for ISDAand really for the OTC derivatives market? India and China specifically.We look at India's GDP outpacing the world.They surpassed China in terms of population recently.By all stretches of the imagination, there's tons of potential there.Again, I'm looking at it from a very broad perspective,but specifically at ISDA, I know there have been a lot of papersthat you've published. Can you talk about, like,what has been done at ISDA? What are we looking at going forward?Yes. On India and China specifically, the growth potential is massive.They have early-stage derivative markets, and you can see wherethey've certain products or certain participants involved,but it's not really the complete package of good risk management.Building out the curve around interest rates,developing a deeper FX market. Both of these countrieshave strong equity positions, but international participantscan engage in that or have hedging tools around credit marketsand securities markets. We see a lot of potentialaround really building out those markets. We have won at our back on that one.These are regulators and market participantsthat are interested in developing their markets further.We're kind of there to help. We've published two papers,one in China, I think, at the end of 2021, and then in Indiamore recently at the end of 2023. We recommended areas where developmentof new products, particularly on interest rate curves,longer out the curve development, increasing the number of participants,for example, pension funds, insurance companies,being allowed to use hedging and derivativeproducts, to support and manage their risk long term is critically important.You can see why a long-term curve would be helpful there,making sure that they have a full complementof risk management tools. Again, we were in India earlier this year,and I just recently returned from a trip to China.There's a lot of interest there. We are also respondingto the regulatory requirements. As you mentioned,the non-cleared margin rules are coming in.India has got its rules underway. We're supporting the VMand specifically the documentation there. We want to make surethat people understand and know how to use the ISDA SIMas a margin model that's been used in over a dozen jurisdictionsworldwide already to align that consistentlythroughout China and India. We've conducted training.We just had the training in China for both market participantsand the regulatory bodies. China is coming along.I expect we will see VM rules at the end of this year, in 2024.IAM rules after that, but they're really interestedin understanding more about the SIM, more about documentation to make surethat they align globally with the current best practices.Again, it's a bit win at our back, but there's a lot of work to be done.Mexico, there's some more work to be done there as well,for the non cleared margin rules. It's always a challenge.We're really focused on international alignment.Many times you go into a new economy or a new jurisdiction,they want to do their rules their own way. Then we kind of like to highlightwhat's already been done and what's already succeeded,and how we align that and why there's a benefitfor their economy to align internationally and to avail themselvesto substitute compliance for other jurisdictions.Again, it's driving best practices, again, driving efficiencyto make sure that everybody can do so in a cost-effective waythat brings market development. It also brings liquidity to their market,which they're also keen to see. -It can't be underestimated.You talk about education and aligning global rules.I'm not assuming that most people in our industryjust assume that that happens. There's a lot of workthat ISDA puts together. Specifically on Mexico, I rememberyour colleagues putting out a list of 20-some-odd piecesof advocacy with Mexico, especially to alignwith the global standards, which they weren't.Now they're getting closer to doing that. Even the use of SIMand the approval process for SIM. It is still a lot of work.It really is. It's amazing what you guys accomplish sometimes.Sometimes I sit back because I was in that chairand say, "We're still doing it." We have to do it, otherwise,the outcome would not be great. I just want to thank you.This is a little bit of a love fest right now, but thank you so much.You've got skin in the game, and we appreciate it.We do, and it makes our lives a lot easier.Then we can tell the story when we go down because we're the solution provider.We're the software solution provider. We're the standard for IM reconciliation.We have to get the regulators there first to say, "Okay,well, at least, yes, you can use SIM." By the way,it's been used since 2015, right? -Yes.Things like that. I just want to acknowledgethat I think it's great stuff. -There's a lot of successaround the table. Whether it's reg reportingnon-cleared margin, non-cleared margin has opened us upto so many other technologies. It's a complete packagewith risk management, technology, and operational efficiencyas well as legal reform and documentation. We've digitized all these documentsso they can be signed and negotiated on platformsusing ISDA Create and other means to really scale this implementation.Everything is about scale and efficiency for us to makeour members' lives easier, right? Support compliance,and make it as cost-effective as possible. -Yes, exactly.Acadia is super focused on these three jurisdictions as well.We've just put out a fact sheet for our clients in Mexico.It is always a partnership between us and the industryto ensure that we can deliver these solutions.Great. Thanks for that, Scott. Okay. Just wrapping up the agenda.You're a former CFTC commissioner, so you were in politics.I can't have a podcast with you without talking a little bitabout politics because there's a lot going on.There's a lot going on in the UK. We have an election next week.There was an election in parliament in the US, where you're from.You live here, I don't. We have an election coming up.There are some shifts going on. I'm always curious,and I'm not going to hold you to anything. I know you had a derivative viewsthat came out a couple of days ago. Kind of touching on some of this.I always wonder, well, what does this mean for my business?What does it mean for us as an industry? Maybe it means nothing.Maybe it's business as usual. I'm always curious to hear from someonein a position like yours. Maybe you've heard things,maybe conversations, things you can share. What does any of thismean to ISDA or to the industry, if anything?I'm pretty sure it's business as usual. What's your viewpoint?I don't want to be too dramatic because changing political windssounds a little bit over the top, but it seemslike there's a shift going on. -Geopolitical risk is always topfive issues for people. Even after implementingthe regs, we had Covid, we had the Russian invasion of Ukraine.These are not election-driven events necessarily. It's kind of the more thingschange the more they stay the same. That's the kind of the wayI view the elections. We've had a number of electionssince the great financial crisis and the regulatory agendahas been consistent. It hasn't changed a lot.There hasn't been significant reforms. There are incremental reforms,and we adjust to that. As you point out, the UK election is on July 4th.They're having their elections. The European Parliamentjust had its elections. France is going to be voting.The U.S. is going to vote in November. There are elections all around the worldthat will have an impact. For sure, we'll respond to that,but I think the elections are kind of the least of our problems right now.It's still some of these other events. When Russia invaded Ukraine,it was the energy infrastructure that was so impacted,and the energy prices went through the roof.That, of course, meant margin went through the roofbecause it's tied to volatility. We were trying to respond to that.How do you deal with the higher price of clearing?What does that mean for the non-cleared marketin trying to find that balance and sourcing collateral?These are the huge impacts on the market that you don't anticipate.COVID, of course, with the dash for cash. The LDI market hereis leveraging the pension funds. Archegos are always raised as issues,and these are beginning to come in. This is a new regulatory theme about this,they call it NBFI, Non-Bank Financial Intermediation.Is there a move from bank driven counterparty riskto more liquidity risk, which I agree there is.We've changed the market structure significantly with the regulation.We have to keep an eye on that as to how it is impacting liquidity.Liquidity is the best barometer for a healthy market.Good, deep liquid markets, that's great. When they get fragile,that's when you start to have problems. That's when you have these sell-offs.You have devaluation of certain assets, and you kind of think about what's next.People are talking about the U.S. Treasury market.We are making that more robust. We are going to be dealingwith the clearing of treasury markets. That's a big deal.A 30-plus trillion market and potentially goingto 40 trillion with the debt. "Hey, who's going to buy all that?"Then, is clearing going to be cost-effective?Where do we source the collateral for all of that?It's not the sky is falling kind of episode here,but it's something we have to keep an eye on.We have to address and these are the kind of thingsthat are on our radar screen. We're really thinkingabout market liquidity quite a bit. Whether you're a bank providing liquidityor you're the buy side providing liquidity, these are valuable.We want to keep them doing what they're doing.We need deep liquid markets, and we want to make surethat the regulatory structure does not make markets more fragileand subject to gapping and price runs. -I'll tease this one.We're not going to talk about it, but there was a BCBS paperthat was written on counterparty credit risk,which touches on a lot of these things. Maybe when you come backfor the fourth time, we're going to talk a little bit about that.We're focusing on it here at Acadia as well,and we'll be talking about that. It all makes sense.Like you said, we've had tons of elections and all these other things,these geopolitical events that happen that you can't predict,or what we have to make sure that we're focusing on,like you said, liquidity is top of mind always.Yes, I think that's going to be an issue for us going forward.Do we have deep, robust markets? Have we set the rules appropriately,and can we source the collateral and the risk management?There are some operational things. We've all got to commit to makingthe collateral system more robust, more automated.Is that tokenization? Maybe. The big thing is making surethat we have sufficient, adequate, deep collateralavailable to do that risk transfer. -Yes, absolutely.I totally agree. All right. Scott, this is great.Thank you for coming here today in-person. Will you come back for a fourth?Oh, I'm in. -We're going to come back here.I love the studio, this is really nice. Anything you want to close withbefore we end? Anything you want to plug for ISDA?I know the AGM is in Amsterdam, right? Next year?Yes, in May of 2025. -It's in May, okay.I'm looking forward to that. -Our superpower at ISDAis bringing the industry together and solving problems.When all the right participants buy-side, sell-side, key infrastructure providerslike yours come together, come up with solutions,then we can implement them. Everybody's had a go at them,everybody's discussed them, they're fully aware.Then the implementation becomes that much easier.Whether it's standardized legal agreements,standardized operational processes, standardized risk management tools,and supporting the efficient implementationof the regulations, it's all in our best interestto make sure we solve these problems as they're comingup and then turn around and get a cost-effective implementation.Make sure you come to the ISDA working groupsand get involved and pay attention to the issues.Actually, our website is full of informationand useful solutions and pree policy. -Exactly. It's available to everybody.Scott, thanks again. Appreciate your time, and we'll be back again.Well, thanks, John, and thanks to Acadia for supporting our efforts.Thank you all for joining in this episode of Ahead of the Curve.I hope you found it interesting. I know I did.If you want to find out more about this podcast and other podcasts,you can find us on acadia.inc or any of your other streaming services.Thank you so much for joining us, and we'll see you again soon. Thank you.
