27 May 2014

Risk.net: Europe little to learn from US clearing roll-out

European authorities are engaging with central counterparties and clearing members to avoid problems associated with the roll-out of clearing in the US, says Kate Wormald from Oesa Partners.

Should European authorities have followed the example of the US in rolling out clearing, phasing compliance and giving the European Securities and Markets Authority (ESMA) the power to postpone start dates?

Although the Commodity Futures Trading Commission (CFTC) did implement a phase-in approach for different types of counterparties, the industry documentation produced by the Futures Industry Association and the International Swaps and Derivatives Association (ISDA) was not available until very late in the day and the deadlines set by the CFTC were still very tight. So, a vast number of negotiations were nowhere near completion and the extended deadlines introduced at the eleventh hour were born out of necessity rather than any leniency on the part of the CTFC. If counterparties were not signed up to centrally clear, they would have been in breach of the regulations if they traded, so the banks would not have permitted this. Consequently, this would have led to market stagnation. It should also be noted that, due to the tight deadlines, the banks were very reluctant to enter into negotiations with their counterparties and there are some quite penal terms in the industry documents that counterparties struggled to amend and, in a lot of cases, I suspect could not.

The CFTC amended the final definition of "US person" in the relevant regulations over the summer of 2013 and a lot of people were caught off-guard by the widened scope. Just before the regulations took effect in September 2013, any counterparties in the UK that were caught by this requirement - not because they were a US person but because the bank counterparty they were trading through had become a US person - had three options: sign up and clear via the US, hence the last-minute chaos; stop trading the financial products that were caught and/or use exchange-traded derivatives (ETDs) instead; or, in advance of the "go live" date, novate and/or transfer their positions to a UK entity that was not a US person, and so avoid the US regulations.

In Europe, the rules are not in force yet. They might only apply from November this year but could easily be rolled into next year as late as the summer. So, in this instance, the US should have perhaps been more pragmatic in its approach as opposed to the other way around. Europeans are starting to look at the requirements and engaging central counterparties (CCPs) and clearing members to avoid what happened in the US. As the new industry agreements are difficult to negotiate, it is a wise thing that some people are preparing to clear and taking a pragmatic approach to be ready by the end of year.

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