Japan, U.S. Seek Swaps Collateral Rule on Time as EU Delays

  • Japanese regulator is reviewing impact of EU postponement
  • Fed Chair Yellen says ‘level playing field’ is important goal

Japanese and U.S. regulators said they intend to impose collateral rules on the $493 trillion swaps market on schedule in September, while leaving the door open to a delay after the European Union said it would miss the deadline.

Financial firms have had enough time to prepare for the standards, and regulators would risk a loss of confidence if they postpone them, said Shunsuke Shirakawa, deputy commissioner for international affairs at Japan’s Financial Services Agency. Shirakawa didn’t rule out a delay by Japan, however, and said the regulator will monitor the fallout from the EU’s “very regrettable” decision.

“It’s not that we don’t have flexibility, and we are currently examining the circumstances,” Shirakawa said in an interview in Tokyo this week.

At issue is a regulation designed to ensure that firms have sufficient collateral to backstop over-the-counter trades to protect against the possibility that one trader’s default could spread risk throughout the financial system. The timing gap threatens to raise competitive pressures, since U.S. and Japanese banks may need to comply with the rules before European firms, possibly affecting billions of dollars in collateral.

Timing Gap

The European Commission, the EU’s executive arm, said earlier this month that it won’t be able to meet the September deadline laid out as a goal by global regulators. Europe plans to complete the regulations by year-end, though they may not take effect until mid-2017.

“It would probably be sounder to implement the rules on schedule,” Shirakawa said. The FSA is collecting information to judge the impact of the EU’s decision, he said. If Japan and others implement the rules on schedule without the EU, European banks may still comply from September, effectively establishing the framework internationally, he added.

Japan’s stance is similar to that set out by Federal Reserve Chair Janet Yellen, who told lawmakers this week that the U.S. is closely monitoring the timing gap.

“If there is a delay in Europe, we need to consider what impact it will have and to work closely with the Europeans,” Yellen said. “The firms are ready to put them into effect,” she said of the rules. “My understanding is that the delay from the EU was going to be short. And we will continue to monitor that, as these are markets where it’s important to have level playing field.”

‘Regulatory Arbitrage’

Global regulators moved after the 2008 credit crisis to coordinate oversight of the swaps-market to prevent the financial industry from exploiting even small differences in the detailed rules and deadlines. The effort involved years of negotiations between banking and market regulators from around the world, with former U.S. Treasury Secretary Timothy Geithner at one point saying that coordination was essential “to prevent regulatory arbitrage and a ‘race to the bottom.’ ”

Different start dates could discourage cross-border trading between banks. The market is dominated by the world’s biggest banks, such as Citigroup Inc. and JPMorgan Chase & Co., which are active around the world.

“Our initial concern is that it may create a disadvantage for U.S. banks,” Marnie Rosenberg, global head of clearing house risk and strategy at JPMorgan, said at a U.S. congressional hearing this month. “We don’t want a delay in timing in one jurisdiction that could create undue burden or uncompetitive -- lack of competitiveness for U.S. firms.”

Large Banks

The International Swaps and Derivatives Association, which represents Barclays Plc and Deutsche Bank AG among hundreds of firms that trade swaps, said the timing differences will probably add to the complexity of trading in the market. ISDA said it is reviewing the implications and considering how to respond.

“On the face of it, the European delay creates an unlevel playing field between European and other large banks, but this will depend on the legal status of each entity and the identity and classification of their counterparties,” said Scott O’Malia, ISDA’s chief executive officer.

The rules require banks to exchange two types of collateral with other banks and with other clients for non-centrally cleared trades. Large banks trading with each other will need to exchange initial margin, collateral at the outset of a trade, as well as variation margin, which is already a common market practice to offset risks during the life of the trade. At the beginning of March 2017, the U.S. rules require banks also to exchange variation margin when they trade with a wider range of clients.

Reduce Risks

Thomas Hoenig, vice chairman of the U.S. Federal Deposit Insurance Corp., said that the requirements will help to reduce risks to the financial system and bolster banks, even if the delay could enable banks outside the U.S. to face fewer restrictions.

“I would note that while it is correct that two foreign banks could trade with one another without exchanging initial margin, I do not view this is a reason to delay U.S. implementation of the rule,” Hoenig said. “U.S. banks play a dominant role in the derivatives market due in large part to their better capital base and they are able to transact business from a position of strength.”

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