Trans-Atlantic Derivatives Fight Nears End as Capital Rules Loom

  • EU's Hill says uncertainty isn't good for market participants
  • `Parameters' of solution `clearer than they were,' Hill says

European Union and U.S. regulators are nearing a deal on oversight of the $553 trillion global derivatives markets that would prevent an increase in EU capital requirements from hitting banks this year.

Jonathan Hill, the EU’s financial-services chief, said an agreement is expected shortly and that progress has been made in negotiations with the U.S. Commodity Futures Trading Commission on supervision of clearinghouses such as those operated by CME Group Inc. and LCH.Clearnet Group Ltd. that are at the center of the market.

“I think the parameters of how we can resolve this look clearer than they were,” Hill said in an interview in his Brussels office last week. “I think that both we and the CFTC hope that we will be able to resolve this soon,” he said.

After more than two years of regulatory wrangling and industry lobbying, EU and U.S. authorities are moving more urgently to reach an agreement, with European requirements for more trades to be settled at the clearinghouses starting to come into force in June and phasing in over two-and-a-half years.

Hill said he and CFTC Chairman Timothy Massad are “keen” to resolve the issue, because “this degree of uncertainty isn’t good for the participants” in the market. “My priority is to get it sorted,” he said, calling the long-running negotiations with CFTC a “regulation saga” that shows the need for better international coordination. Steve Adamske, a CFTC spokesman, declined to comment on the talks.

‘Shut Out’

Under the rules, certain trades done before or after Feb. 21 -- but before the relevant clearing obligation kicks in -- will also have eventually to be cleared, meaning firms are already planning how deals will be conducted.

The lack of an equivalence finding threatens the ability of U.S. clearing companies to compete with European rivals for the interest-rate swap business starting in February, according to John Gulliver, research director at the Cambridge, Massachusetts-based Committee on Capital Markets Regulation.

“As soon as Feb. 21, U.S. clearinghouses will be largely shut out of the most liquid OTC derivative market in the world -- interest rate swaps,” Gulliver said by e-mail. The committee includes executives at banks, hedge funds and asset managers, according to its website.

At issue in the EU-U.S. talks are differences on collateral policies for clearinghouses. After the 2008 financial crisis, regulators in the U.S., EU and elsewhere sought to curb risks building up directly between traders by requiring greater use of clearinghouses that stand between buyers and sellers and receive collateral from both sides.

Eurodollar Futures

The two sides have been discussing policy changes that would enable European authorities to make a key finding that U.S. rules are equivalent to their own and strong enough that extra capital isn’t necessary to protect against losses. Under European rules, derivatives settled at clearinghouses that meet EU standards are cheaper, requiring less capital than those deals done at clearinghouses that fail to pass the test. The European Commission has already granted equivalence to clearing rules in countries including Australia, Japan and Singapore.

As a result, without an equivalence finding, European banks would face a major hike in capital requirements when they use U.S. clearinghouses such as CME’s, which processes some of the most widely-traded derivatives in the world, including Eurodollar futures and options. That has led CME and banks to press repeatedly for an end to the trans-Atlantic dispute.

Client Collateral

UBS AG, Barclays Plc and other EU-based derivatives-brokerages account for about a quarter of overall customer collateral held by banks to backstop trades on U.S. exchanges, according to a Futures Industry Association review of CFTC data from November. European lenders have more than $34 billion in client collateral, the group said.

The EU is seeking public comments on a change to collateral policies that may speed up a final equivalence determination. The European Securities and Markets Authority, the EU market regulator, in December proposed amending its rules to allow European clearinghouses the option of offering some U.S.-style collateral rules. Under the proposal, European clients could use the U.S. system for futures and other exchange-traded derivatives.

Without the change, ESMA said “a loss of market shares,” for European clearinghouses, “is to be feared” because clients could shift their deals to the U.S. ESMA, which is receiving public comment until Feb. 1, said it was proposing the policy in order “to ensure a level playing field.”

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