EU Derivatives Clearing Fight With U.S. Moves Toward Resolution

  • ESMA proposes allowing 1-day initial margin on gross amount
  • Move would allow EU, U.S. to offer equivalence to each other

European Union regulators are considering amending rules on central clearing of derivatives trades in a bid to end a long-running dispute with the U.S. that threatens to fragment markets.

The European Securities and Markets Authority on Monday proposed to reduce the amount of collateral needed to cover potential losses to one day’s activity on a position, as in the U.S., from two days as is currently the situation in Europe. The rules would apply to gross omnibus accounts and individual segregated accounts for exchange-traded derivatives and securities -- essentially futures and options -- and doesn’t affect the swaps market, where contracts are traded bilaterally.

Central clearing 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. The EU-U.S. dispute is over how much collateral -- known as initial margin -- should be put up when a trade is initiated.

“The change would bring the EU rules on how central clearers calculate margin into line with those in the U.S.,” said Pauline Ashall, a derivatives partner at Linklaters. “It gives clients an alternative option they didn’t have before. I would now expect the U.S. to reciprocate.”

Potential Loss

The dispute between the two sides centers on whether initial margin should be calculated as the gross amount a trade could lose in one day after a counterparty defaults, as in the U.S., or whether it should be two days, which European regulators have said they view as being more robust. Under EU rules, traders are allowed to calculate a potential loss for two days net of potential gains on other positions.

Derivatives traders have been calling for an agreement to be reached between the U.S. and Europe because a failure for the two sides to recognize each other’s regimes could hurt EU banks, which would have to hold more capital for cross-border trading. It may also undermine the competitiveness of clearinghouses if they’re disadvantaged by their home country’s rules.

Last week, the EU prolonged a transition to new capital rules on how banks and their subsidiaries handle their exposure to central counterparties. The extension to June 15 allows more time for companies to adjust to the new rules because clearinghouses in the EU and in other countries need more time to go through the process of being authorized or recognized under the European Market Infrastructure Regulation.

Under ESMA’s proposal, clients opting to use one-day gross margin will have to calculate intraday collateral if there are price movements, something many may be neither willing nor able to do, Ashall said. The consultation ends on Feb. 1, 2016.

“This is an important proposal because allowing clearinghouses in the EU to calculate margin on the same lines as U.S. clearing houses do should enable the EU and U.S. to accept each other’s rules as ‘equivalent’ and to do so without potentially putting EU clearinghouses at a commercial disadvantage,” Ashall said.

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