ANALYSIS-EU, U.S. supervisors face derivatives test
By Huw Jones
LONDON, Sept 15 (Reuters) – Differences between new European Union and U.S. rules to crackdown on derivatives will be a key test of how well transatlantic regulators can coordinate to iron out loopholes banks may be tempted to exploit.
The United States has already approved a law to tighten supervision of the $615 trillion off-exchange derivatives markets and the EU published its own draft law on Wednesday.
Both implement pledges the EU and United States made as members of the Group of 20 countries (G20) to require central clearing of as many contracts as possible, reporting of trades to repositories and where appropriate, trading on an exchange.
“The crunch item to get right is for trade repositories to make sure every regulator has access to all the data they have,” said Damian Carolan, a partner at Allen & Overy law firm.
“I don’t think there are any massive showstopper obstacles and there is enough recognition for third country solutions,” Carolan added.
EU Internal Market Commissioner Michel Barnier is to meet his U.S. counterparts to ensure “we are operating in parallel”.
But industry experts and lawyers say plugging the gaps will test how much supervisors in the EU and United States can go beyond the positive noises to actually trust each other’s day-to-day supervision on the ground.
Will they be willing to allow the banks they regulate to clear and report trades across the Atlantic, lawyers ask.
The fear among supervisors is there will not be full and unfettered access to trading data held outside their jurisdiction when the next crisis hits.
Off-exchange derivatives trading has largely been a seamless, transatlantic market focused on London and New York.
It is dominated by a handful of banks like Morgan Stanley, Goldman Sachs and Deutsche Bank who want to avoid duplication of supervision, conflicting rules and extra red tape that could distort competition.
A U.S. clearer ICE has come to dominate credit default swaps clearing in Europe.
The U.S. DTCC has become the world’s main repository for CDS transactions but recently agreed to set up a subsidiary in Europe to reassure local supervisors they have full access to data at all times.
Asia faces its own challenges about what to do with clearing and trade reporting as many of its banks carry out the trades in Europe or the United States and local markets are too small to support a clearer or data bank.
The EU draft law toned down earlier hints that clearing houses and repositories should be based on the bloc’s soil to ensure speedy access to data at any time.
“Every difference between the U.S. and EU approach can lead to regulatory arbitrage. It can be at the price of distorting market functionality and taking away core freedoms,” said Anthony Belchambers, chief executive of the Futures and Options Association, a European industry lobby.
“It’s difficult to convert the differences into costs but in the EU text it does look like we have moved away from this sort of nationalism around the location of central clearing houses and trade repositories,” he said.
Transatlantic differences include:
— The United States law says transactions that are centrally cleared must be executed on an exchange or swap execution platform. The EU derivatives draft does not look at execution venues and the bloc won’t examine this until 2011.
— The U.S. law forces banks to “push out” trading of equity and commodity-linked derivatives to affiliates but there is no such provision in the EU draft.
— U.S. derivatives dealers may be subject to the Volcker Rule’s curbs on proprietary trading in some derivatives. The EU has rejected such a rule.
— Clearing house collateral from a U.S. derivatives customer will have to be held in the United States. Unclear if the EU will insist likewise for EU customer collateral.
— There are differences in how the United States and EU want to ringfence a client’s collateral to safeguard it from any insolvency of a clearing member.
— Both EU and U.S. laws offer clearing exemptions to non-financial companies that use derivatives to hedge risks such as adverse currency moves, but it’s unclear if these exemptions will work in the same way.
— The U.S. law regulates large size swaps participants but there is no intention to do this in the EU unless they are carrying out a lot of business.
Although the United States has already approved its sweeping reform of Wall Street, much of the implementing details have yet to be fleshed out.
Policymakers and legal experts hope this process will take place at the same time as EU approve its draft so that transatlantic differences can be largely ironed out. (Reporting by Huw Jones, editing by Mike Peacock)
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