United States: EU-US Agreement On Regulation Of Central Counterparties

On 10 February 2016, the European Commission and the CFTC announced a common approach regarding supervision of central counterparties operating in the US and EU, paving the way for cross-border equivalence and recognition decisions. The agreement promises to resolve a major and long-standing impasse which has threatened to paralyse the financial markets.

EU-US Agreement on CCPs

On 10 February 2016, the European Commissioner for Financial Stability, Financial Services and Capital Markets Union and the US Commodity Futures Trading Commission (CFTC) announced a common approach regarding recognition of their respective regulatory frameworks for clearing central counterparties (CCPs).1

Following this agreement, the European Commission intends to adopt an equivalence decision to declare that the CFTC requirements for derivatives clearing organisations (DCOs) under the agency's jurisdiction are equivalent to requirements under the European Market Infrastructure Regulation (EMIR).2 This will allow such US CCPs3 to be recognised under EMIR and to continue to provide services in the EU whilst complying with CFTC requirements, although they will need to comply with certain additional requirements under EU rules as discussed below. The European Securities and Markets Authority (ESMA) has also announced that whilst it has 180 days to recognise CCPs under EMIR, it will do everything within its powers to shorten that period, given the 21 June 2016 deadline for the start of the clearing obligation.

CFTC staff will propose a determination of comparability with respect to EU requirements, which will permit EU CCPs that are registered or intend to register with the CFTC as DCOs to provide services to US clearing members and clients whilst complying with corresponding EU requirements in lieu of CFTC requirements. CFTC staff will also propose streamlining the registration process for an EU CCP wishing to register as a DCO.

Equivalence under EMIR

Under EMIR, the European Commission may adopt equivalence decisions declaring that:

  • the legal and supervisory arrangements of a third country ensure that CCPs authorised in a third country comply with legally binding requirements equivalent to requirements in EMIR;
  • those third country CCPs are subject to effective supervision and enforcement in that third country on an ongoing basis; and
  • the legal framework of that third country provides for an effective equivalent system for the recognition of CCPs authorised under third country legal regimes.

Such decisions are necessary for CCPs established in third countries to provide services in the EU. To date, the European Commission has adopted equivalence decisions for the regulatory regimes for CCPs in Australia, Hong Kong, Japan, Singapore, Canada, Mexico, South Africa, Switzerland and the Republic of Korea.4

Key Differences between the US and EU Regulatory Regimes

In September 2013, ESMA published its final technical advice on the US's regulatory equivalence to EMIR. The technical advice highlighted various differences between the US and EU regulatory regimes, resulting in a delay in the European Commission adopting an equivalence decision for the US. This delay has, in turn, contributed to the delayed application of capital requirements under the Capital Requirements Regulation (CRR)5 in the context of EU banking groups' exposures to CCPs, as absent an equivalence decision, European clearing members would need to hold more regulatory capital to clear on US CCPs than if recognition were granted to US CCPs.

The announcement that an equivalence decision from the European Commission is forthcoming is prefaced on the proposed resolution of a number of differences between the US and EU regulatory regimes which are of economic importance. In the absence of harmonisation, it has been feared that a flight of derivatives markets away from the EU may have occurred due to lower collateral requirements and therefore reduced costs of clearing transactions in the US. We discuss below the main differences between the EU and US regimes and resolutions that facilitate an equivalence decision under the new agreement:

Minimum Liquidation Periods

A liquidation period is the time period used for the calculation of the collateral that the CCP estimates is necessary to manage its exposure to a defaulting member. Essentially, a CCP examines the maximum predicted possible price movement over the liquidation period to calculate a baseline figure for initial margin. Under EMIR, the liquidation period applicable to exchange-traded futures contracts must be at least two business days. For customer positions, clearing members may post margin on a net basis (Two Day Net).

Under the US regime, the minimum liquidation period for exchange-traded futures contracts must be at least one day.6 For customer positions, clearing members must post margin on a gross basis (One Day Gross).

In December 2015, ESMA published a Consultation Paper7 proposing to amend the liquidation period provisions for customer accounts with the aim of addressing the difference between Two Day Net and One Day Gross. The proposal permits One Day Gross in the EU if certain conditions are met, including that the identity of the client is known to the CCP, the client is not an affiliate of a clearing member and the CCP implements procedures to: (i) calculate for each account, initial and variation margin requirements at least every hour during the day; and (ii) collect margins within one hour where the new margin requirement meets certain thresholds.

Whilst this new flexibility has been widely welcomed, the proposed conditions for One Day Gross are controversial. ESMA's proposals are intended to facilitate equivalence between the US and EU regimes but the conditions imposed by ESMA for One Day Gross have raised significant concerns in the market, including that such conditions are not required under the US regime or could lead to other undesired consequences and further non-equivalence. For example, it is a significant deviation from all other EU financial legislation to treat affiliates differently. It would be strange to exclude such positions when affiliates are often themselves acting as intermediaries for other clients. It is also to be hoped that ESMA will clarify that their "known to the CCP" condition is not intended to mandate so-called "leapfrog payments" by CCPs to clients, a structure proposed in EMIR which ESMA itself has acknowledged is unworkable in many situations.

The common approach contemplates that US CCPs seeking recognition in the EU will have to provide in their rules for two day margin on clearing members' proprietary accounts as a condition of equivalence. The common approach does not specifically address customer accounts, presumably pending the conclusion of the consultation on customer account margin.

Countercyclical Buffer

EMIR requires a CCP to establish transparent and predictable procedures for adjusting margin requirements in response to changing market conditions. In doing so, CCPs are required to employ at least one of a number of options including applying a margin buffer at least equivalent to 25% of the calculated margins which it allows to be temporarily exhausted in periods where calculated margin requirements are rising significantly. By contrast, the US regime does not contain such a specific or numerical procyclicality buffer. The common approach announcement states that US CCPs seeking recognition will need to have internal margin models that include measures to mitigate the risks of procyclicality, although the specific terms of this requirement remain to be seen.

"Cover 2" Default Requirements

Under EMIR, CCPs are required to maintain default resources sufficient to cover a default by the two largest clearing members (Cover 2). Certain US CCPs are only required to maintain default resources sufficient to cover a default by the largest clearing member. The common approach announcement states that US CCPs seeking recognition in the EU will need to maintain Cover 2 default resources. However, because US CCPs that have been determined to be systemically important and those that have elected to be subject to additional standards (so-called "subpart C DCOs") are currently required to satisfy Cover 2 under CFTC rules, this condition is unlikely to have a significant effect on most DCOs seeking recognition.

Exception for Agricultural Derivatives

The common approach announcement provides that these additional conditions will not apply to US agricultural commodity derivatives traded and cleared domestically within the US, in light of the nexus of these contracts with the US economy, the importance of the contracts to US agricultural providers and the low degree of systemic interconnectedness of agricultural products with the rest of the financial system.

CFTC Actions under the Common Approach

The common approach contemplates that the CFTC will implement a substituted compliance regime for DCOs to facilitate the ability of EU CCPs to satisfy "a majority of" DCO requirements through compliance with EU supervisory standards, although it is not clear at this stage which DCO requirements will fall into this category. The common approach does not appear to change the CFTC's position that EU CCPs will still need to register as a DCO in order to provide clearing services in the US or to US clearing members and clients, but would reduce the compliance burdens of such registration by allowing such DCOs to comply with EU requirements instead of CFTC requirements. The CFTC has also stated it will streamline the registration process for EU CCPs seeking DCO registration.

How precisely the CFTC will implement the common approach has not yet been specified. In particular, it seems likely that the CFTC must prepare and propose a determination of comparability concluding that the EU requirements for CCPs are comparable to most of the regulatory framework for DCOs, and in the process identify any requirements that are not comparable. With respect to streamlining the DCO registration process for EU CCP registrants, it is unclear whether the CFTC would proceed by amendments to its rules or through an exemptive order or no-action relief. In any such actions, the CFTC will likely need to consider and address any concerns that the relief to be extended to EU CCPs could threaten the competitiveness of, or otherwise adversely affect the position of, US CCPs. In any case, the common approach contemplates that such actions will be undertaken within the same timeframe in which the European Commission is expected to adopt an equivalence decision for US CCPs and complete the process for their recognition under EMIR.

Footnotes

1 The announcement is available here.

2 Regulation (EU) No 648/2012 on OTC derivatives, central counterparties and trade repositories.

3 The common approach does not address the equivalence of the US requirements applicable to securities clearing agencies that are registered with the US Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934. The statement notes that the European Commission continues to discuss with the SEC an approach that may lead to a similar EU equivalence decision for such clearing agencies. The announcement does not explicitly address how the common approach will apply to US CCPs that are both registered DCOs and securities clearing agencies (and such matters may therefore need to be addressed in the details of implementation), although such entities must at a minimum comply with the CFTC rules and, accordingly, one would expect that the common approach would apply at least with respect to activities within the scope of such CFTC rules that are to be deemed equivalent.

4 You may like to view our client note "Update on Third Country Equivalence under EMIR" dated 18 November 2015, available here. Equivalence decisions are available here.

5 Regulation (EU) No. 575/2013 on prudential requirements for credit institutions and investments firms.

6 For cleared swaps on a financial underlying asset, both the US and EU require a minimum five-day liquidation period for the margin calculation.

7 The consultation paper is available here.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Barnabas W.B. Reynolds
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.