Proposed increases to liquidity buffers for UK-based trading venues and central counterparties (CCPs) in preparation for OTC derivatives being cleared and traded on exchange may need to be reinforced once impending European legislation takes effect.
The UK financial regulator, the Financial Services Authority (FSA), is replacing current ”liquidity buffer' obligations in favour of a risk-based approach which could see minimum capital requirements rise about 22%. The new approach is designed to ensure UK market infrastructures are adequately protected against losses that can arise in stressed market conditions and that funds can be accessed when necessary.
Analysts have suggested the new measures will not lead to dramatic changes in operations or any undue burden compared with European competitors. “The change is not so significant that it will drastically affect CCPs or exchanges,” said one exchange analyst. “It is simply an attempt to set the UK up for derivatives clearing requirements.”
The Group of 20 political leaders has demanded that the vast majority of OTC derivatives are standardised for trading on exchange-like platforms and clearing via CCPs to reduce counterparty risk. To take account of these and other market changes, the FSA is proposing an average increase to the minimum level of capital for each UK trading venue and clearing house of £5.7 million – a median increase of around 22% – the FSA revealed in a consultation paper.
Affected organisations are recognised investment exchanges and clearing houses, including CME Clearing Europe, Euroclear UK and Ireland, EuroCCP, ICE Clear Europe, ICE Futures Europe, Liffe, LCH.Clearnet, the London Metal Exchange, the London Stock Exchange Group (LSE) and Plus Markets Group. The rules do not impact UK-registered multilateral trading facilities (MTFs) such as Chi-X Europe.
The FSA also said it would consult on proposals to undertake a more “intrusive approach” in supervising existing credit risk management for CCP services.
But a source at a European think tank said the proposed measures would not harmonise the UK framework with pending legislation. “If anything, MiFID II is much tougher and liquidity buffer requirements will need to be increased again once it comes in,” he said.
While the watchdog insisted the financial crisis of 2008 had not exposed any critical weaknesses in the current capital requirements regime, significant developments in the market infrastructure landscape since their creation meant the guidelines needed to be modernised. Since the UK's current liquidity buffer guidelines were introduced in 2001, through the implementation of the Financial Services and Markets Act, many market infrastructures have transformed from mutual organisations into commercial enterprises. There have also been significant regulatory developments – such as the global regulatory standard on bank capital adequacy and liquidity (Basel), Europe's Markets in Financial Instruments Directive (MiFID) and the soon-to-be-finalised European market infrastructure regulation (EMIR) – which, along with planned revisions to MiFID, will set the rules for more transparent and competitive trading and clearing of cash and derivatives instruments in Europe.
EMIR will also place limits on how CCPs can invest in order to minimise exposure to external risks. Particularly, CCPs will not be able to invest their capital in their own securities or those of its parent or subsidiary undertaking. LCH.Clearnet, which is currently in exclusive merger talks with the LSE, announced earlier this week that it would now allow gold bullion to be used as collateral, in an attempt to provide greater choice and flexibility to customers. Both the LSE and LCH.Clearnet declined to comment on the FSA proposal, however a spokesperson for Chi-X Europe said the new rules would help to level the playing field between exchanges and MTFs.
“It would appear that the FSA consultation proposes to bring exchanges closer to the standards imposed on MTFs,” the spokesperson said, noting that, like MTFs, exchanges would now have to conduct an analysis of risks and hold appropriate capital. “In this case, it is consistent with our view that in many areas, regulation of MTFs is more stringent than that for exchanges.”