As new CFTC chairman Timothy Massad meets his European counterpart Michel Barnier this week, it is clear that if the relationship has not hit a rough patch, both sides still have a lot more talking to do. For so long discussions have centred around definitions of “US person” in the Dodd-Frank Act but now that is being replaced by a new issue: European authorities’ recognition of US clearing houses. The touchstone stems from Article 25 of the European Market Infrastructure Regulation (EMIR), which allows European banks to use authorised clearing houses outside the EU.
For the overseas clearing house, authorisation depends on two factors: recognition by ESMA and recognition by the commission that the clearing house’s foreign jurisdiction is equivalent. No fewer than 35 clearing houses from around the world have applied for recognition, and the deadline has been pushed back to December 15. Here it get further complicated. Europe has tied its clearing rules to new rules around banking capital ratios, giving people tremendous incentives for using them but also making the standards tougher than anywhere else in the world.
Key to the incentive system is that banks using qualified clearing houses may subject their trades to a 2 per cent risk-weighted capital charge. This jumps to as much as 50 per cent if the EU doesn’t recognise the clearing house. The CME reckons that could amount to capital charges in excess of 30 times current levels for some deals. For the big derivatives dealers, it would add up to millions of dollars of savings daily in the amount of collateral they are required to put up. The problem is that any bank with dollar swap interest rate exposure hedges it with eurodollar contracts in Chicago. Investors are able to trade eurodollars in London via ICE Clear Europe, but the bulk of the product’s business remains Stateside.
Consequently there are a lot of nervous European banks. Nor would it be just those with large US exposure, such as Barclays and Deutsche, that would suffer. The CME is equally aware of what it could lose. “There could be “unfortunate consequences” if it wasn’t recognised. “[Some of our members] face a big capital cliff,” warned Kim Taylor, head of CME Clearing last week. The problem is Europe’s capital requirements also come into effect on December 15.
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