European Commission Scores CFTC Risk Rules

Terry Flanagan

The European Commission has criticized a U.S. regulator’s approach to risk management for derivatives clearing organizations (DCOs) as overly complex and inconsistent with principles adopted by global regulators.

The U.S. Commodity Futures Trading Commission on August 16 adopted a final rule on enhanced risk management for systemically important derivatives clearing organizations (Sidcos).

The rule requires a Sidco that is involved in activities with a complex risk profile or that is systemically important in multiple jurisdictions to meet its financial obligations notwithstanding a default by the two clearing members that have the largest combined exposure for the Sidco in extreme but plausible market conditions (a Cover Two requirement).

In a September 13, 2013 comment letter, Patrick Pearson, head of the European Commission’s Integral Market and Services Directorate, argued that the bifurcation of Sidcos would result in DCOs being subject to multiple and competing rules.

“There is no compelling argument to draw a distinction between internationally active Sidcos and non-internationally active Sidcos,” said Pearson.

An internationally active DCO that serves foreign clearing members or foreign trading venues is by nature systemically important, he said. Conversely, it is hard to imagine that a systemically important CCP in the U.S. would not be systemically relevant at an international level, given the size of U.S. markets covered by such a CCP and the interconnectedness between financial institutions.

The European Commission recommends dropping the distinction between internationally-active and non-internationally active Sidcos.

“The multiplication of layers in the regimes applied to CCPs in the U.S. would be detrimental to the objective of building equal conditions of fair competition between CCPs registered in the U.S. and those which operate at the global level,” said Pearson.

The International Organization of Securities Commissions (Iosco), in a report released on August 12, 2013, noted that financial market infrastructures (FMIs) should have a set of recovery tools that allows the FMI to allocate uncovered losses, cover liquidity shortfalls, and replenish its financial resources in order to continue to provide services.

The recovery plans should identify the FMI’s critical services and address any underlying structural weaknesses. CCPs should have tools in place to allow them to re-establish a matched book, including mechanisms that incentivize a successful auction of unmatched contracts.

CME Group, in a comment letter, expressed unease about the informal conversations it’s had with the CFTC and the Federal Reserve Bank in which doubts have been expressed by both regulators about whether U.S. Treasury securities can be counted on as “qualifying” liquid resources to the extent that they are utilized in connection with prearranged and highly reliable funding arrangements.

CME said that this would be in conflict with the Principles for Financial Market Infrastructures (PFMI) that was adopted by Iosco in April 2012.

“The Commission should revise the proposed regulation to be consistent with the language of the PFMI, which allows for CCP flexibility for liquidity planning services,” said Kim Taylor, president of CME Clearing. “This flexibility would greatly reduce the cost to CCPs and the market of dealing with liquidity risk, without any material increase in risk to the market.”

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