01 June 2016

TABB Forum: Europe, clearing equivalence and the SEC

The world’s largest equity derivatives clearinghouse, OCC, has been placed on CreditWatch with a negative outlook by S&P, damaging the clearinghouse’s ability to comply with European clearing standards.

If OCC cannot comply with the equivalent rules, European banks will face significantly higher capital requirements to clear at OCC, severely disrupting the US options market.

Further, in its rating of OCC, S&P observes that: “OCC lacks the pool of liquidity resources that would enable it to settle, at a 99 per cent confidence level, the securities transactions of the largest two Clearing Members (should they default at the same time). This is in contrast to the ‘Cover 2’ minimum standard that European peers must meet.”

The European Commission (EC) reached equivalence with the Commodity Futures Trading Commission (CFTC) in March of this year. The lengthy negotiations between the two parties resulted in a lot of column inches; talks between the EC and the Securities Exchange Commission (SEC) have been less prominent, but are no less important.

The EC repeatedly postponed its capital requirement deadline as talks with the CFTC were ongoing. The current deadline is June 15, although the EC has said it will delay the implementation date another six months as it negotiates with the SEC. Eventually, however, European banks will have to start holding increased capital against trades conducted at foreign clearinghouses.

That is, unless the clearinghouse is deemed equivalent to European clearinghouses, is approved by the European Securities and Markets Authority (ESMA) and becomes a Qualified CCP, or QCCP. All CFTC-regulated clearinghouses, including ICE and CME, are now deemed to be QCCPs in Europe; therefore, European banks need not hold added capital against trades conducted at these venues.

Should the SEC and EC not reach an equivalence agreement by June 15 (now likely Dec. 15, 2016), however, then European banks will have to hold significantly more capital against trades conducted at OCC – this would be disruptive to market activity, since OCC has a monopoly on clearing equity options in the US.

The EC/SEC negotiations are also of importance to DTCC, the other major US clearinghouse that is regulated by the SEC.

The repeated postponements to the implementation of the new capital rules by the EC during negotiations with the CFTC suggest that the same outcome is quite likely here, too. But the S&P report on OCC states that it, “lacks the pool of liquidity resources that would enable it to settle, at a 99 per cent confidence level, the securities transactions of the largest two Clearing Members.” Equivalence matters not a jot – OCC is not in a position to become a QCCP.

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