ECB Questions Non-Euro CCP Supervision

Shanny Basar

A European Central Bank board member said the UK’s exit from the European Union creates uncertainty regarding the future of the supervision of non-euro area central counterparties that clear significant amounts of euros.

Yves Mersch, member of the executive board of the ECB, said in a speech at the Cumberland Lodge Financial Services Summit yesterday that CCPs are systemically relevant and have been a focus of regulators and central banks since the financial crisis.

Mersch said the prospect of Brexit creates uncertainty regarding the future of the supervision of non-euro area CCPs that clear significant amounts of euro currency. He continued that as the future relationship between the EU and the UK is unknown, he did not wish to speculate on this matter.

“We are ready to explore all options within our mandate to ensure we can continue to fulfil our responsibilities under the [EU] Treaty, i.e. promoting the smooth operation of payment systems and ensuring the effective transmission of monetary policy, for which the stability of the centrally-cleared repo segment of euro money markets is crucial,” Mersch added.

The ECB has previously tried to move the clearing of euro transactions away from London and into the Eurozone but the UK won a lawsuit to prevent this happening. However the UK may not have access to the bring a similar cases at the European Court of Justice after Brexit.

Che Sidanius, director of financial services at KPMG, said at a conference in August: “30% of LCH volume [the clearer owned by the London Stock Exchange Group] is in euros and the Germans and French have always wanted this business.”

MiFID II also requires exchange-traded derivatives to be transacted on an authorised EU venue and for EU authorised CCPs to provide clearing services, unless there is an equivalence decision. Equivalence is when European regulators recognise that the legal, supervisory and enforcement arrangements of a non-EU country are equivalent to EU  requirements. Counterparties who clear trades through a non-equivalent CCP have to set aside more regulatory capital which will make these trades more expensive.

Michael Thomas, partner at law firm Hogan Lovells, said in webcast in August that the UK already meets EU regulations so there is no reason that UK-based CCPs should not be given equivalence. “However politics is crucial and there are moves afoot to ensure euro-denominated clearing takes place in the EU,” he added.

Thomas continued that In the worst case scenario, where the UK cannot clear euro-denominated transactions, then UK CCPs would need to set up an EU-incorporated CCP which is both timely and expensive, as the new operation will need, for example, its own capital, default fund and collateral.

This year the European Commission agreed an equivalence decision on derivatives clearing organisations in the United States after many years of negotiations. Thomas pointed out that after leaving the EU, the UK will have to negotiate its own agreement with US regulators. “‘We would expect the US CFTC to agree but nothing is certain in international negotiations,” he said.

For the first time, the latest surveys from the Bank for International Settlements included data on positions with CCPs. As at the end of June 2016, 62% of the $544 trillion in notional amounts outstanding in over-the-counter derivatives reported by dealers was centrally cleared according to yesterday’s combined semi-annual and triennial BIS surveys of positions. The report continued that central clearing is reshaping OTC derivatives markets by facilitating the compression of trades and has led to an increase in the relative share of uncleared instruments on dealers’ balance sheets, in particular foreign exchange derivatives.

While three-quarters of outstanding OTC interest rate derivatives contracts were cleared through CCPs, this fell to 37% for credit derivatives and was less than 2% for OTC foreign exchange and equity derivatives.

The BIS said this was because non-deliverable FX forwards, deliverable FX derivatives and equity derivatives have often exempted from regulatory requirements for mandatory clearing of standard OTC derivatives.

“That said, many regulators are also starting to require higher capital and margin for non-centrally cleared derivatives, which strengthens the incentive to move trades to CCPs,” added the BIS. “In the United States and other key markets, margining requirements began to be phased in starting in September 2016, and therefore their impact on clearing will only become clear in future data.”

Among interest-rate instruments, the share of positions booked against CCPs is highest for forward rate agreements at 91% and then interest rate swaps at 80%. However for interest rate options, the share of CCPs is close to zero.

The growth of clearing was demonstrated this week by Swedish financial technology company Cinnober separating its client clearing business, which provides real-time clearing technology and services to large international banks, into a separate subsidiary.

Cinnober said in a statement that the technology can handle all traded asset classes, as well as trades that take place both on and off an exchange, so clients can use their capital more efficiently and be more operationally efficient.

In 2015 the European Commission included Cinnober’s initial venture for real-time clearing for banks in a financing program with the ambition of promoting European innovation. Cinnober received partial funding of the development of this technology and said the potential for the offering is so great that the operations should be run by a separate company.

Veronica Augustsson, chief executive of Cinnober, said in a statement: “After analyzing the need for our solutions in real-time clearing, we are confident that the demand for improved post-trade technology among banks is substantial. For several reasons, focus in particular, now is the right time to form a separate company for this.”

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