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20 March 2015

Tabb Forum: The need for equivalence in European and US clearing rules

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ESMA has not yet judged the US standards to be equivalent to its own. As a result, the cost of clearing at US institutions for European banks could be cripplingly expensive.

Europe has linked its regulatory framework concerning central clearing to the new capital requirements laid out in CRD IV, meant to reflect Basel III in appropriate circumstances. To “de-risk” the system, these requirements greatly encourage banks to put their OTC trades through CCPs, since this is seen as the safest way to operate – central clearing of OTC contracts was one of the 2009 G20 responses to the global financial crisis, with a CCP acting as a buyer to every seller and a seller to every buyer. The implementation of globally harmonized regulatory frameworks around these systemically important infrastructures has not been smooth, with a battle having being fought over extraterritoriality, the manner in which one jurisdiction can impose its rules upon another. FATCA is an example of this emanating from Washington.

The major point of difference between the two regulators is around margin requirements at CCPs, with Europe having imposed a tougher margining framework than the US. It therefore carries over that they will need to hold increased capital on their balance sheets against trades conducted at non-QCCPs in order to mitigate the failure of that CCP, something deemed to be more likely by ESMA than at those CCPs it recognizes.

If banks are using Qualified CCPs (QCCPs), those approved by ESMA in Europe, then the banks can subject their trades to a 2 per cent risk-weighted capital charge. If they are clearing through a CCP that is not recognised by ESMA, then this capital charge leaps up. This is to reflect the greater perceived risk exposure generated via clearing at a non-QCCP. The QCCP title is handed down by a CCP’s local regulator, so for the purposes of equivalence with Europe, the regulatory framework in which a CCP operates still needs to be approved by ESMA.

CME Group estimated that this could result in capital charges as much as 30 times in excess for banks not using QCCPs. It is, therefore, very important for US clearing houses to be recognized in Europe. The implementation of CRD IV in Europe already has been pushed back twice as a result of this delay in judgement on equivalence, most recently to June 15, 2015. ESMA and the CFTC have been discussing the best path to equivalence for two years now, with some hope of it being reached soon. At the FIA conference in Boca Raton, Timothy Massad, chairman of the CFTC, said that his organization agreed to a lot of the changes requested by Europe in order to find harmonisation – a partial compromise – although he added that they “would not be making significant changes.”

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