Extraterritoriality and volumes make future uncertain for CCPs
CCPs around the world face an uncertain future says Aite
The number of central clearing counterparties is likely to rise in the near future as new entrants put Latin America, Africa and Australia on the map for OTC derivatives clearing, but with more regulatory intervention expected and unpredictable customer flows, the new venues face an uncertain future according to a new report by analyst firm Aite.
The global push to centrally clear OTC derivatives is an ongoing saga that has led to regulatory change on both sides of the Atlantic and into Asia. The core concept is to improve transparency and lessen counterparty risk by moving to a CCP-clearing model. Under that model, each party in the transaction enters into a contract with the CCP and avoids taking on the risk of the other defaulting.
Although the original plan was to have OTC derivatives cleared through CCPs by the end of 2012 at the latest, Aite says it has taken many months of drafting, consultation and amendment as well as public debate to bring the new rules to bear in the US and Europe. The obligation to clear takes effect in Europe later this year, while in the US that obligation is being phased in by asset class. The most affected asset classes are credit default swaps, interest rate swaps and FX and currency swaps.
The rules are complex due to the number of different regulators and jurisdictions involved, as well as the global nature of the OTC derivatives market itself. The Committee on Payment and Settlement Systems and the International Organisation of Securities Commissions have issued guidelines for CCPs which aim to raise minimum requirements, provide more detailed guidance and broaden the scope of existing standards. A set of 24 principles was issued in April 2012 requiring CCPs to introduce minimum margining requirements for clearing members, hold additional capital and liquidity reserves and meet new governance and operational risk management requirements – but Aite warns that these guidelines are not legally binding and as such may not always be followed.
Aite cautions that extraterritoriality remains a major issue for all participants in the OTC derivatives market. The CFTC has been criticised for the impact its rules will have on non-US counterparties. On 4 December, the International Swaps and Derivatives Association, the Securities Industry and Financial Markets Association and the Institute of International Bankers sued the CFTC. According to Aite, this was because of “defects” in the regulator’s guidance and policy, including an alleged failure to establish a full cost-benefit analysis for the cross-border derivatives rules.
The definition of a “US person” is another contentious point, which includes investors and trades that may have minimal US involvement. To muddy the waters further, the SEC and the CFTC cannot agree on the precise definition. The CFTC views the activities of a foreign branch belonging to a US firm as still falling under the definition and therefore liable.
The CFTC has required only the simplest products to be centrally cleared, but it plans to increase the number of OTC asset classes that must be cleared, including more CDS and IRS as well as energy swaps and equity index swaps. However in Europe, the rules are much broader in scope. EMIR’s requirements cover credit, interest rates and certain FX, equity and commodity derivatives. They include more historical contracts. The European definition generally includes all derivatives except spot transactions and FX forwards made for commercial purposes.
Further disputes about the new rules exist in Europe. The UK FCA does not consider FX forwards, non-deliverable currency forwards and spot transactions for FX and commodities to be derivatives liable under the new reporting and clearing rules, but the European Commission does. Furthermore, there are some exemptions: pension funds have a three year exemption until 15 August 2015 and on-financial counterparties are exempt if their non-hedging trading volume is below a preset level, either €1 or €3 billion depending on asset class.
EMIR’s deadlines are uncertain, according to Aite, partly because they rely on the European Securities and Markets Authority submission of the draft regulatory technical standards for clearing on 15 March. The standards will need to be endorsed by the European Commission, Parliament and Council, at any stage of which there could be objections and delays. Even once all of these obstacles are passed, the phase-in period has yet to be decided.
In Asia Pacific, different countries have taken differing approaches to reform. In Japan, the regulator quickly drafted regulation in line with the G20 agreement, whereas sin China it has been slow to indicate whether it will introduce OTC derivatives clearing requirements, although a local CCP has been established in Shanghai. Australia began exploring mandatory clearing of IRS in July 2013, but little has yet been decided and a further report is expected imminently. In Hong Kong, regulator the HKMA expects mandatory clearing for OTC derivatives to begin in July 2014. In India, there is no regulatory timeline for central clearing of OTC derivatives but the local CCP CCIL has begun preparations to strengthen its ability to clear these instruments. The Reserve Bank of India decided to adopt the CPSS-IOSCO principles in July 2013. It has been speculated that mandatory clearing will be introduced at some point in 2014,but this remains uncertain.
Singapore has not introduced mandatory clearing, but the country’s regulator the MAS has indicated that IRS denominated in Singapore dollars and NDFs in Asian currencies will fall within the scope of the rules. OTC clearing already exists in the country, where SGX has been clearing OTC commodity derivatives since 2006 and IRS since 2010. In Korea, voluntary clearing for OTC derivatives is practiced and in March 2013 it introduced legislation to create CCPs for these markets. In September, KRX was authorised as a CCP. Mandatory clearing of Korean won IRS is due to start on 30 June, with CDS expected to follow later.
Several other countries, including Argentina, Brazil, Canada, Chile, Mexico, Russia, Saudi Arabia, South Africa and Turkey are at varying stages of progress towards OTC clearing. At one end of the spectrum, Canada is working towards mandatory clearing, execution and reporting requirements. At the other, Saudi Arabia has indicated that central clearing is not required because trade volume is not sufficient to justify such a move. In the middle, there are countries such as Turkey, where OTC derivatives dealing is prohibited, but under the proposed Capital Markets Law the Capital Markets Boards of Turkey would be able to designate clearing agents to centrally clear OTC derivatives transactions or to require CCPs be established. The Law is currently being worked through Turkey’s Parliament, where the outcome is not yet decided. Russia has already implemented trade reporting requirements for OTC repo trades and FX swaps, but there is no mandatory clearing as yet.
