FIA Europe, a derivatives industry trade body, is urging agreement by European Union and United States regulators on mutual recognition of central counterparties (CCPs) next month to avoid a major disruption to trading.
“European recognition of US clearing houses under the European market infrastructure regulation (EMIR) is the biggest immediate issue faced by the derivatives industry,” said Simon Puleston Jones, CEO of FIA Europe.
The Capital Requirements Directive IV (CRD IV) – the legislation which enforces the new Basel III capital adequacy regime in Europe for banks and other financial institutions including market infrastructures – imposes a deadline for recognition and authorisation of non-European CCPs of 15 December.
But Puleston Jones says the issue needs final resolution in the next month if regulators are to avoid significant disruption to the derivatives markets. “Not only would a large number of buy-side clients of EU clearing brokers need to start looking for new clearing brokers, but the impacted banks would also need to reconsider how they clear their house business and promptly put the necessary arrangements in place.”
The first European clearer authorised under EMIR was Nasdaq OMX Clearing in March. If US CCPs are not recognised under EMIR, the cost to European clearing members of clearing derivatives trades on behalf of European clients in the US would sky-rocket because of the extra capital charges they will incur under CRD IV.
“In the absence of EMIR recognition being granted by 15 December, European clearing members may need to hold 150 times more capital to continue to clear on US CCPs than would be the case if recognition were granted,” said Puleston Jones.
For European institutional investors, there is a very real prospect of not being able to clear US business because of constraints on US clearing brokers’ ability to take on additional business.
“Whilst this is potentially a franchise-threatening issue for EU clearing members, it is a mistake to assume that US clearing members are rubbing their hands with glee at the prospect,” added Puleston Jones.
“With the balance sheet constraints imposed by Basel III’s leverage ratio and the broader increase in regulatory capital costs that would result, US clearing members have limited capacity and appetite to take on the risk that would need to be passed on by their European peers.”
The extraterritorial implications of new European and US rules have hampered the global implementation of the G-20 mandate to centrally clear standardised OTC derivatives. In February this year, European Commissioner Michel Barnier and Mark Wetjen, acting chairman of the US Commodity Futures Trading Commission, confirmed their commitment to a joint ‘path forward’ to harmonise European and US regulatory frameworks, but progress has remained slow on the mutual recognition of the ability of central counterparties to handle the additional risks involved in central clearing of swaps and other OTC derivatives.
Differences between US and European regulators are believed to centre on margin rules and the amount of collateral that would be delivered to CCPs in the event of default. Puleston Jones believes mutual recognition of clearing houses before the December deadline will require a spirit of compromise by both sets of regulators.
“If the issue is not resolved in September, there is a risk that it is kicked back up to the G-20, which meets in November,” he warned. “This would be suboptimal for all involved, as it may prove to be too late in the day, and takes the negotiations out of the hands of the very rule-makers and regulators on both sides of the Atlantic who are most familiar with the complexity of the issues involved.”
FIA Europe’s concerns are shared by the Committee on Capital Markets Regulation (CCMR), which recently sent letters to the European Commission and CFTC, outlining the steps they needed to take to avoid disruption to EU-US cross-border derivatives trading. The CCMR points out that outcomes-based analyses have demonstrated that the US and EU rules “result in broadly consistent customer margin levels” despite differences in detail.
FIA Europe is the European arm of the Futures Industry Association (FIA), following an agreement by the Futures and Options Association and the FIA to combine their organisations last year.