A recent European Commission proposal to oblige EU-based eligible counterparties to hold an active account at an EU central counterparty clearing house has raised temperatures in some quarters. The measure is intended to reinforce the EU’s “open and strategic autonomy” in the field of clearing to address a deficit in EU oversight and intervention caused by non-EU businesses managing products that the EU considers “systemically relevant”. This has been seen as particularly problematic by some UK-based businesses which trade in such EU financial products.
The European Commission made this proposal in December 2022. From the EU point of view, as put forward by Matthias Graulich, the chief strategy officer and executive board member of Eurex Clearing, a central clearing counterparty, it’s normal to want to be in a position to manage one’s systemic risks appropriately. He spoke at Thursday’s Luxembourg for Finance webinar on the capital markets union.
“Clearing” means the correct and timely transfer of funds to the seller and securities to the buyer. A “counterparty” is the party on the other side of a transaction. A “central counterparty clearing house” is an entity that helps to facilitate trading in various European derivatives and equities markets
In 2021, the European Securities and Markets Authority, known as Esma, identified three financial products which it deemed systemically important from risk and monetary policy perspectives. These are euro-denominated interest rate swaps, a forward contract in which one stream of future interest payments is exchanged for another; euro-denominated credit default swaps, a financial derivative that allows trading one’s credit risk with another investor and EuriBor futures, a contract permitting speculation on the price direction of the Euribor rate.
Limited oversight
These products, explained Graulich, are now being managed by market infrastructures outside the EU, “primarily London and following Brexit, there is a limited kind of oversight and intervention possibility for EU authorities.” In order to deal with this, Eurex started what Graulich described as a “partnership programme” to build a liquid alternative for clearing Euro denominated interest rate swaps within the EU.
This programme has been moderately successful, achieving a 20% market share, with 600 clearing members and clients being on-boarded. “Obviously the 20% seems not sufficient from an EU Commission risk management perspective,” said Graulich.
Graulich explained the EU partnership has considered its options. Doing nothing has been unsuccessful. A “straight location policy”, which requires those clearing trades in a certain security to be located in a given jurisdiction, as for example Japan has imposed for yen derivative trading. However, Graulich explained, this approach has “a lot of unknowns and potential risks.”
Draft Emir 3.0
What Graulich depicted as the middle option is an active account requirement, such as was stipulated in the draft Emir 3.0 directive.
Philip Whitehurst, the head of service development at LCH’s rates derivative business, took the opposite view, disagreeing openly with Graulich. He portrayed the directive as going against the stated ambitions of the capital markets union, of getting money flowing across the EU through “deep, competitive, efficient and reliable sources of funding”. From that perspective, he said, “it’s really hard for us to see how the Commission proposal for active accounts helps towards these objectives.”
LCH is a British clearing house group that serves major international exchanges through two subsidiaries. Whitehurst pointed to the OTC derivatives markets as being global.
“By their nature, the major international currencies that facilitate global trade are obviously primarily the dollar, but also euros trade in global markets,” said Whitehurst. “The infrastructure that supports them, therefore, necessarily needs to be global.”
Healthy global market
To Whitehurst the current situation is a “healthy global playing field”, where “CCPs compete on merit for customer business.”
Whitehurst pointed to statistics showing that the euro is more internationally traded than even the US dollar. The higher euro figure is “a real success story,” he said.
The EU decision to impose an active account requirement, he said, “goes right down to the level of individual firms and individual portfolios and reinforces that fragmentation, limits that free choice. That does seem odd to us.”
He said the Commission should have looked at imposing enhanced supervisory frameworks.
Regulatory divergence
Graulich argued that market infrastructure must adhere to minimum standards, like the EU’s, the Emir directive. “Clearly, based on what we have heard out of the UK, there is some risk of regulatory divergence down the road.”
“The way our business is operating globally”, replied Whitehurst. “We essentially are held to … the highest of high standards.”
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