Europe Likely to Resolve Clearing Conflict With U.S., LSE Says

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Traders work the floor of the New York Stock Exchange in New York, N.Y., on Friday, May 08, 2015.

Photographer: Michael Nagle

The U.S. and Europe are going to find a way to get along, at least when it comes to regulating clearinghouses meant to protect financial markets, according to London Stock Exchange Group Plc’s chief executive officer.

Officials on both sides of the Atlantic have repeatedly clashed over standards for central clearing firms. The companies stand between traders, holding capital and collateral to ensure losses at a trading firm don’t harm its counterparties. They’re seen by regulators as a firewall to prevent a repeat of the 2008 crisis, when interconnections between firms threatened the financial system.

At issue is whether U.S. standards are robust enough to satisfy the European Commission, and whether discrepancies would give a region or a company an unfair advantage. A failure to achieve recognition could hurt European Union banks, which would have to hold more capital for cross-border trading. It could also be a problem for the competitiveness of clearinghouses if they’re disadvantaged by their home country’s rules.

“Ultimately we believe regulators will find a way and get to an agreement,” Xavier Rolet, LSE’s CEO, said Tuesday in an interview at Bloomberg’s European headquarters in London. “If clearinghouse equivalence isn’t resolved, clients would eventually start moving their business from one jurisdiction to another. Customer flows would be impacted by reduced choice and higher costs.”

LSE is the majority owner of clearinghouse LCH.Clearnet Ltd. The company’s SwapClear cleared a notional $642 trillion in 2014, a 26 percent increase from the prior year, according to filing.

Rule Clashes

In the EU, the commission determines if another country’s rules are as strong as the 28-nation bloc’s own standards, by making so-called equivalence decisions. Its officials have been engaged in more than two years of talks with the U.S. Commodity Futures Trading Commission on derivatives rule clashes. The latest round of discussions took place in Brussels last week.

“I think both regulators want a level playing field,” Rolet said. Failure to have similar standards could spur financial firms to try to exploit discrepancies between the different nations’ regulations.

“The bottom line is that there are still unresolved issues that could result, if unaddressed, in competitive tension driven by looser risk standards,” he said. “That’s not something anybody wants.”

In an effort to reduce systemic risk, European rules give an incentive to banks to use clearinghouses that are regulated to the same standard as those in the EU.

Reducing Risk

Doing so will lower the risk weighting of trades, a key measure for determining banks’ capital requirements, to as little as 2 percent. This figure is multiplied by a factor of 10, or more, for trades with non-qualifying clearing firms.

A failure to reach an agreement on mutual recognition could end up costing dealers in London or Paris more money when they’re seeking to hedge interest-rate positions using eurodollar contracts, for example, because most of the derivatives are cleared by CME Group Inc. in Chicago.

The EU and the U.S., meanwhile, have made competing claims on who has the toughest standards.

They have said that the key remaining stumbling block in the negotiations relates to differences in their respective margin rules. The European Commission has said that relatively stricter EU rules could make European clearing firms less competitive than their U.S. rivals.

Margin refers to money that traders must post at a clearinghouse to cover the risk of a default.

Managing Default

“The one thing you don’t want is clearinghouses competing with each other on the basis of margins,” Rolet said. “Their business is default management, so you want them to compete with each other on service, on innovation and fees, but not on margins.”

Timothy Massad, chairman of the CFTC, told a European Parliament committee last week that “there are some areas where European rules are more conservative, and many where our rules are more conservative.”

Following last week’s talks in Brussels, Massad and Jonathan Hill, the EU’s financial services chief, said that they’re pushing to finalize their approach by the summer.

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