The International Swaps and Derivatives Association (ISDA) has published a white paper outlining a series of recommendations to make the clearing of derivatives in the European Union more attractive.
The vast majority of euro-denominated derivatives – 90% – are managed by London based LCH, according to data provider OSTTRA.
Market participants in Europe are concerned over the financial stability risks to the bloc from €83 trillion of open euro derivatives contracts being cleared in a market that is not in its direct oversight.
The trade group’s grouped its recommendations into three three distinct objectives – broadening the range of market participants clearing in the EU, ensuring EU central counterparties (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, according to ISDA.
For example, it said 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.
Further measures could be taken that would better position EU CCPs to compete on a global basis.
These include adjusting the supervisory framework to accelerate the launch of new products by EU CCPs and expanding the operating hours of Target 2 and Target 2 Securities.
This would extend the window that market participants can pay margin calls in euros and post securities as collateral.
ISDA notes that removing unnecessary barriers to clearing in the EU could also be achieved by eliminating duplicative and conflicting requirements for those EU firms that operate internationally.
In addition, 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 help.
“It’s important to note that these measures would help build on already strong foundations,” it added.
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, ISDA notes that 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.
It said, “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.”
“Of all the proposals outlined in the ISDA report, encouraging the use of post trade risk reduction (PTRR) services to increase efficiency of EU derivatives markets including EU clearing is perhaps the most important, ” says Kirston Winters, chief risk officer (CRO), OSTTRA.
He adds, “By exempting these risk reducing trades, that result from PTRR, from the derivatives trading and clearing obligations, regulators could increase usage of PTRR services and improve efficiency in the EU market making it more attractive.
Interestingly, the EU recently identified the UK’s plans to exempt the risk reducing trades, that result from PTRR, from the derivatives trading and clearing obligations as part of the wholesale markets review as an area that would make the UK derivatives market more competitive.”
