US and European regulators have reiterated their commitment to achieving equivalence between the two regimes for central counterparty clearing firms this summer, but signs of any compromise over the thorny issue of margin requirements for cleared futures remain few and far between.
“We’re confident that we will be able to disentangle this issue in a relatively short time frame,” Verena Ross, executive director of the European Securities and Markets Authority told delegates at the FIA’s International Derivatives Expo (IDX) in London today.
But the gulf in margin requirements at US and European CCPs is proving difficult to bridge.
Under the European Markets Infrastructure Regulation, clearing members are required to post margin calculated on a two-day liquidation period to cover their house accounts, while the US approach under Dodd Frank employs a one-day margin methodology – something that Europe believes is not enough to cover potential defaults.
ESMA’s Ross highlights issues surrounding the Lehman Brothers’ failure as evidence that one-day margin may not be sufficient to cover member defaults. She highlighted evidence from the Valukas report that showed margins collected by CME on the Lehman’s own account position were insufficient to close the positions without losses in three asset classes out of five.
“It was a pure and lucky coincidence that the default fund was not impacted,” she told delegates
“It is not prudent to assume that the portfolio composition of a clearing member will ensure that, if the margins collected in one asset class are insufficient, the margins collected in other asset classes will be sufficient to compensate that.
On a separate panel, CME chief executive Phupinder Gill noted that Lehman’s commodity contracts were adequately settled using only the bankrupt dealer’s house account, and in a relatively short time frame.
“For its energy contracts at the CME, Lehman auctioned its own portfolio. US$2bn of notional was auctioned in 45 minutes and losses were funded entirely from the house account,” he told delegates on a panel of exchange leaders.
CFTC boss optimistic
Speaking at the same event in a separate keynote address, CFTC chairman Timothy Massad confirmed that in spite of the key differences in approach, he too anticipated an equivalence agreement by the summer.
While there are still big issues to be ironed out, the two regions are no longer at logger-heads, but working closely to analyse the difference between the two approaches.
“I believe we are making good progress. I expect that we will get there,” said Massad.
He noted a meeting with EU commissioner for financial services, Jonathan Hill last month, during which a number of key issues were resolved, in particular the terms of substituted compliance framework.
“I believe we have narrowed the other issues being discussed, and we have agreed to address those issues in a data-driven way – by agreeing on what analysis needs to be done to look at the potential effects of differences in our regulatory systems. In particular, we are looking at margin methodology issues with respect to futures,” he told delegates.
At the heart of the issue is that the differences in approach are two-fold. While Europe’s two-day margin requirement for house accounts undoubtedly produces higher margin than the US method, the fact that customer margins are collected on a net basis by European CCPs compared to a gross basis by US CCPs, means that the overall level of margin collected by US CCPs could be higher, particularly given that house account margin reflects just 14% of total CCP margin according to CFTC estimates.
Recent analysis from the CFTC and presented last month to the European Parliament shows that the gross approach to customer accounts produced US$58bn of margin compared to US$23bn for the net approach for the nine largest clearing members.
In today’s keynote speech, Massad expressed surprise that at his first meeting of OTC derivatives regulators a year ago, the European Commission did not include the US in its list of five jurisdictions that would be deemed equivalent with respect of the regime for CCPs – a central pillar of the G20 agreement that was signed by global leaders back in 2009.
However, he believes that significant progress has been made and that is set to continue. “We have achieved a great deal of harmonization already. And we will achieve more in the future. It takes time, it requires us continuing to work in good faith,” he said.
