Working for a Positive Outcome on Euro Clearing

ISDA Chief Executive Officer Scott O'Malia offers informal comments on important OTC derivatives issues in derivatiViews, reflecting ISDA's long-held commitment to making the market safer and more efficient.

The European Commission (EC) is determined to increase the allure of clearing in the EU as it looks to reduce what it sees as an over-reliance on systemically important third-country central counterparties (CCPs). Making EU clearing more attractive is a principle we support, but it will require a multi-faceted strategy to achieve this – one we’ve set out in a new whitepaper published earlier this week.

Key to making the EU more attractive as a clearing hub is fostering an open market structure that is competitive and cost-effective – an approach we think would be far more successful than one that erects barriers to accessing non-EU CCPs. Ultimately, market participants should be free to choose where they clear, based on their own commercial and risk considerations. Our whitepaper recommends 15 specific and practical steps that can be taken to achieve these objectives.

The recommendations can be grouped into three distinct objectives – broadening the range of market participants clearing in the EU, ensuring EU CCPs can compete with those elsewhere, and removing unnecessary barriers to clearing in Europe. The suggested measures range from legislative changes to adjustments in market practices and CCP processes. Some may be fairly straightforward to implement; others are likely to take more time.

For example, EU authorities could consider recommending that public entities clear on a voluntary basis – a relatively simple move that could increase liquidity in the European clearing market and bolster domestic capacity. Policymakers could also make clearing more attractive to pension scheme arrangements by tackling concerns they have about finding sufficient cash to meet variation margin calls. The recent situation in the UK has shown how quickly this vulnerability can put financial stability at risk. Developing a central-bank-backed service that provides collateral transformation to buy-side participants would increase clearing.

Further measures could be taken that would better position EU CCPs to compete on a global basis. These include adjusting the supervisory framework to speed up the launch of new products by EU CCPs and expanding the operating hours of Target 2 and Target 2 Securities, extending the window that market participants can pay margin calls in euros and post securities as collateral.

Removing unnecessary barriers to clearing in the EU could be achieved by eliminating duplicative and conflicting requirements for those EU firms that operate internationally. Encouraging the use of post-trade risk reduction (PTRR) services by introducing a conditional, limited exemption from the clearing obligation for PTRR non-price-forming technical output transactions would also help.

It’s important to note that these measures would help build on already strong foundations. While UK-based CCPs clear a high proportion of interest rate swaps denominated in global currencies, including the euro, the share of EU CCPs has increased since Brexit. In fact, Eurex has a larger market share in euro-denominated over-the-counter (OTC) interest rate derivatives (IRD) than CME’s market share in US dollar-denominated OTC IRD.

There is no single silver bullet that will further enhance the appeal of clearing in the EU, but we believe the steps outlined in our paper collectively have the potential to achieve lasting change. The result will be an open market structure that promotes competition and avoids barriers, creating an incentive for firms to clear in the EU. As policy proposals are thrashed out, ISDA will continue to engage with EU policymakers to discuss our recommendations and help them to achieve their objectives while retaining safe and efficient derivatives markets.

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