INTERVIEW | How heavily will the competitiveness of European CCPs and capital markets weigh, against EU member-state governments’ perceived need for caution? With an arm wrestle possibly coming up – between the EU Parliament and the Council, at least around some of the opposing ideas that each of them has pursued so far – industry association EACH is weighing in with the Parliament side on key issues. PostTrade 360° spoke with EACH’s policy chief Elena Tonetto and secretary general Rafael Plata. 

How long should a central counterparty clearinghouse (CCP) in the EU have to wait for the regulatory approval when making changes to the calculation models that determine their requirements for collateral from their clearing members, or when adding new “products” such as offers to clear a new asset class? Max 70 working days, as the European Commission has proposed, or for extended periods of up to several years, as has been all too common?

In the eyes of the European Association of Clearing Houses, EACH, this is a top issue at stake as the European Union is about to finalise the third generation of its EMIR framework – the European Market Infrastructure Regulation – through the winter. The team is now working hard to convince decision makers of the benefits of faster approvals, while assuring them that it will not put the financial system at risk. 

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“The key thing to remember is why this legislation initiative is there,” says Rafael Plata, who is afraid that the European Council – that is, the assembly of representatives from the EU member-state governments – risks losing that big picture while its delegates zoom in on the sub-aspects that are in their national focuses. 

“What this legislation is saying is ‘we’ve done a lot on the resilience and efficiency, but what about the competitiveness, is our industry competitive enough?’.”

He sketches a context of “different jurisdictions trying to compete to make sure that all their industries are globally competitive”. In this, clearing is not just its own industry, but a main component of the underpinning to the financial market as a whole.

But will it?

The great financial crisis around 2008 put clearing under regulators’ attention. And while clearinghouses were seen as having weathered that crisis well (such as in the spectacular wind-down of Lehman positions at LCH), the first two generations of EMIR were focused on guaranteeing the markets’ crisis resilience. But securities markets and big CCPs are largely global, not least in the clearing-heavy derivatives area. According to the CCPs themselves, at least, but also the Commission, the regulatory circumstances could be more favourable for the EU-based clearinghouses. EMIR 3, the update package that is now up for a series of crucial political decisions in the coming weeks and months, has been initiated to add improvement along this competitiveness dimension. So, will it? 

With the question going to Rafael Plata, the answer is a worry that, in a worst-case outcome, it would not even improve things at all. 

“The result of the discussion among the member states, in the Council, is a proposal that wouldn’t change much, compared with today – or could even make the situation worse,” he says, citing one association member who said it would even prefer today’s status quo over the Council’s proposal for change. 

National interests in play

In the EU’s lawmaking process – delicately designed to balance the power between central bureaucrats (Commission), directly elected politicians (Parliament), and member-states governments (Council) – the proposal from the Commission has now filtered down through the other two bodies. Their positions are being formally announced now around the November-December turn. Judging by the signals ahead of their publications, the CCP industry is tying its hope to what it perceives as a forward-leaning stance on the side of the European Parliament – while fearing that the final regulation could be confined by a much more restrictive position on the side of the European Council. Together, the separate EU bodies will boil down the proposal to a joint text over the coming months. 

“Their interests, and objectives, are a bit different,” comments Elena Tonetto, Senior Policy Adviser of EACH.

“In EMIR 3, it would be good if we could see these objectives and practices more streamlined.”

For EU-based clearinghouses, this approval procedure for the new products and risk model changes runs at the national regulatory authorities per each actor, rather than centrally. EACH’s analysis of its own data revealed that such approvals, on average, take a whopping two and a half years from first application to final regulatory go. (Regulators have pointed fingers back, citing poorly crafted first-version applications as a contributing factor.) The European Commission’s proposal is seeking to limit this to 70 working days – a suggestion that the Parliament (and EACH) have expressed support for. The Council, however, has leaned towards sticking with longer time limits, allowing for their scrutiny. 

“I do understand that the national authorities, from their point of view, want to do everything that they consider necessary, also not be liable in the future if something happens. This leads to approvals taking a lot of time. But at the same time, this is detrimental – because too long time means bad time to market, and also a higher risk in case an existing risk model is not well calibrated,” says Elena Tonetto. 

EU designing incentives 

Outside this issue of approval time frames that is now highlighted by EACH, another much-discussed aspect of EMIR 3 has been the EU’s incentives to promote its own clearing firms versus the British-based ones that have recently come to be based outside the Union. These incentives are motivated by purposes of both stability and competition. In our coverage at PostTrade 360°, we have touched on this now and then – with the EU’s rationale lined out for example in this 2022 conference session, and criticism against it from Bloomberg columnist Marcus Ashworth reported here. This contest plays out not least in the asset-type area of euro-denominated interest rate swaps (IRS), with the main clearing players being Germany’s Eurex versus Britain’s LCH – owned respectively by their nations’ stock exchange groups. Both Eurex and LCH are members of EACH. A much-discussed proposal from the EU camp is that market parcipants should be required to hold an “active account”with an EU-based CCP. A lingering question mark for the industry is what the term could actually mean, when technically defined, which it is not yet. 

Energy firms could use bank guarantee for margin

But are there other EMIR aspects that EACH is weighing in on, beside the approval wait? On the list, Rafael Plata also sees competing EMIR 3 proposals on certain sub-topics known as “supply-side measures”, a collective term for rules that apply to the clearinghouses, to strengthen them. On the issues of these supply-side measures, too, EACH is generally finding the Parliament’s proposals more apt than the Council’s. 

(These measures being “supply-side” makes them distinct from “demand-side measures”, which apply to clearing members and their market-participant clients.) 

As an example of supply-side measures where EACH will be happy to see progress, Rafael Plata mentions the possibility for energy market participants to pledge bank guarantees as margin to guarantee their trading positions at the CCP. A type of relevant cases could be when an electricity provider, which deals in derivatives to offset its exposure to market price swings, suddenly faces requirements to post large sums of cash in response to a spike in market volatility. 

“This solution was used in Europe until 2016 and is currently used in the US and Canada.”

Easier direct connections

Other supply-side measures relate to the ease by which large market participants, for example money market funds, can access a CCP directly without going through an intermediary clearing member. A third example is the regulatory openness for an exceptional procedure known as porting. It becomes useful when a clearing member defaults, and its next-tier clients, who are healthy market participants that have done nothing wrong, need to turn to a different clearinghouse. By the standard procedure, their counterparty positions must be closed, and they may then need to go through a know-your-customer procedure with their new clearing member. The sale of their assets could potentially contribute to flooding the market at the worst of times, accelerating value drops. Porting, instead, allows another clearing member to take over the client with exposure as-is, with a temporary waiver for the client vetting. 

With the positions of the European Parliament and European Council both disclosed now around the shift of November to December, the winter will allow for their “trilogue”
– a process where they negotiate with each other and with the European Commission, to agree on final text. This “level 1” regulation could be published around March. After that, more precise details on how it should be implemented will be published as so-called regulatory technical standards (RTS), “level 2” regulation that is prepared by the European Securities and Markets Authority (ESMA) – with eventual adoption by the Commission, under acceptance by the Parliament and Council.