Ending years of negotiations, the CFTC announced it has reached an important agreement with the European Commission regarding margin requirements for derivatives clearinghouses (central counterparties or CCPs). Under the agreement, the European Commission plans to adopt an “equivalence” decision that will allow U.S. clearinghouses to continue to provide clearing services in the E.U. by complying with U.S. requirements, subject to certain conditions and procedural requirements. This will allow U.S. CCPs to avoid onerous capital charges in the E.U. Similarly, CFTC staff will propose a determination of comparability concluding that a majority of E.U. requirements are comparable to CFTC requirements, allowing E.U. CCPs to meet certain CFTC requirements by complying with the corresponding requirements in the European Market Infrastructure Regulation (EMIR). U.S. agricultural contracts were excluded from the agreement.
CFTC Chairman Timothy Massad said, “Our agreement is critical to ensuring that our global derivatives markets remain robust, while keeping our financial system as stable and resilient as possible. It is a significant milestone in harmonizing regulation of these markets.” CFTC Commissioner J. Christopher Giancarlo also supported the agreement, saying it avoids higher costs for U.S. farmers, ranchers, financial institutions, energy firms and manufacturers.
U.S. Treasury Secretary Jacob Lew echoed the sentiment that the agreement was an important milestone in cross-border regulation and urged both sides to swiftly implement it. Walt Lukken, head of international derivatives association FIA, welcomed the announcement, saying it ended uncertainty for market participants ahead of the start of the E.U. mandatory clearing obligation in June.
Clearinghouse margin. The impasse arose because margin requirements for clearinghouses in the U.S. and E.U. use different methodologies to compute the amount of margin to be collected. U.S. CCPs use a one-day minimum liquidation period, and the European regulatory regime requires a minimum two-day period. The U.S. follows a policy of gross collection and posting of customer margin, in which the clearing members must pass on to the CCP the full amount of initial margin for each customer. In contrast, E.U. rules allow for netting: if one customer’s exposures offset another’s, then the clearing member can post initial margin netted across customers.
Extensive data analysis found that U.S. margin methodologies typically result in more margin being collected for customer accounts, but E.U. margin methodologies typically collect more margin for house accounts. Both sides favored their own margin system.
The differing requirements had significant repercussions for U.S. clearinghouses because under E.U. rules, in order to be a “qualifying CCP” and receive favorable capital treatment under the E.U. Capital Requirements Regulation, CCPs must be from a jurisdiction that has been declared to have “equivalence” to E.U. clearinghouse regulations. The E.U. had previously declared equivalence for many jurisdictions, but due in part to the stalemate over margin requirements, not for the U.S. The E.U. rules will require central clearing for interest rate swaps starting June 21, 2016.
Agreement. The agreement provides that the European Commission will soon propose an equivalence decision for U.S. CCPs, subject to conditions relating to margin for proprietary positions, measures to mitigate the risk of procyclicality, and maintenance of “cover 2” default resources. (Procyclicality relates to the risk that if a CCP needs to call for additional margin during stressful circumstance, that, in itself, can put additional stress on the system.) The agreement also provides that the European Commission will shortly propose the adoption of an equivalence decision under EMIR to determine that US trading venues are equivalent to regulated markets in the E.U. This is meant to provide a level playing field between E.U. and U.S. trading venues for the purposes of the MIFID I framework.
The conditions will not apply to US agricultural commodity derivatives traded and cleared domestically within the U.S. According to Massad, the exception requires a strong nexus to the U.S., involving U.S. products and U.S. delivery points. The exception was made due to the importance of these contracts to U.S. farmers and ranchers and their limited international impact.
Before the European Commission may adopt an equivalence decision, E.U. member states must vote in the European Securities Committee. After a decision has been adopted, ESMA will complete the process for recognizing applicant U.S. CCPs. During the recognition process, CFTC-registered U.S. CCPs will benefit from any transitional relief under the Capital Requirements Regulation, including any extensions.
Within the same timeframe, CFTC staff will propose a determination of comparability, concluding that a majority of E.U. requirements are comparable to CFTC requirements. This determination will provide a basis for E.U. CCPs already registered with the CFTC as derivatives clearing organizations, as well as those seeking registration, to meet certain CFTC requirements by complying with the corresponding requirements in EMIR. CFTC staff will also propose to streamline the process for E.U. CCPs seeking registration.
Market certainty. Jonathan Hill, commissioner for Financial Services, Financial Stability and Capital Markets Union, said in a statement, “It has taken a long time, but it is good news that after more than three years of discussion, we are now able to provide certainty for the marketplace.”
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