U.S., Europe Liaise on Clearing

Terry Flanagan

With the emergence of swap execution faciltities and the subsequent central clearing of trades as mandated by Dodd-Frank and Emir, the world’s clearinghouses are becoming increasingly important as points of risk in the global financial system, according to U.S. Commodity Futures Trading Commission Chairman Timothy Massad

One of the most important cross-border issues before the Commission is clearinghouse recognition and regulation. “This is an issue that transcends swaps,” Massad told a U.S. Senate committee on Thursday. “It is of equal concern to participants in the futures and options markets because the same clearinghouses handle clearing for many products.”

The CFTC is in dialogue with its European counterparts to facilitate their recognition of U.S. clearinghouses. Such recognition is necessary in order for European firms to be able to continue to transact business in U.S. markets.

Currently, 14 clearinghouses are registered with the CFTC to clear swaps, futures, or both. Five of those are organized outside of the U.S., including three in Europe. One such European clearinghouse, which has been registered with the CFTC since 2001, now handles approximately 85% of swaps clearing, Massad said. In addition, the CFTC is now reviewing three additional registration applications from clearinghouses outside the U.S.

After considerable discussion, European rule makers agreed that the framework of dual registration and cooperative supervision should not be dismantled but should be augmented by a framework for substituted compliance for European clearinghouses. “We worked hard to come up with that substituted compliance framework, and I believe that, if we can work through the rest of our differences, we have a framework that is satisfactory to both the EC and the CFTC,” said Massad.

Following that agreement, however, the European Commission advised the CFTC that it was still not able to find its supervisory regime equivalent and grant recognition to U.S. clearinghouses because it is concerned that the margin methodologies used by U.S. clearinghouses are inferior to theirs and create an unacceptable level of risk to Europe.

“We disagree, and our discussions have been focused on these issues, in particular our respective rules on margin methodology for futures,” Massad said. “We follow a policy of gross collection and posting of customer margin for a minimum one-day liquidation period.”

That is, the clearing members must pass on to the clearinghouse the full amount of initial margin for each customer. The Europeans’ methodology is based on a two-day liquidation period, but it permits netting: if one customer’s exposures offset another’s, then the clearing member can post initial margin netted across customers. To see how these different approaches compare, the CFTC provided them an analysis using actual data for seven days.

“What we found was that one-day gross was substantially higher than two-day net for each clearing member, and for each day,” Massad said. “That is, the total amount of customer margin under one-day gross was as high as 421% of the amount under two-day net, and was never less than 160% of that amount. We have since looked at two other clearinghouses, and found even larger percentage differences.”

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