Dr. Apostolos Thomadakis, head of research at the European Capital Markets Institute (ECMI), speaks exclusively to BEST EXECUTION on the tension between the EU and its member states when it comes to derivatives clearing – why he does not believe the revised regulation will fulfil the regulator’s ambitions, and why a centralised supervisory authority is urgently needed to reduce risk and encourage cross-border transactions.Â
Clearing is critically important for capital markets as it reduces the systemic risk posed by OTC derivatives. Well-developed and resilient CCPs do not only support trading and ensure good management of risks stemming from derivatives transactions, but they also allow capital markets to function efficiently and transparently. As in the case of banks, a systemic problem in clearing is a problem for everyone. That is why the European Commission is concerned and wants to ensure that EU CCPs are safe and well supervised.
In December 2022, the Commission proposed a new clearing package, EMIR 3.0, which has two clear objectives. First, to develop a competitive and efficient clearing system within the EU, and second, to reduce the dependence – and consequently the risk exposure – on systemic non-EU CCPs. To achieve these objectives, the EMIR 3.0 proposal included measures that will encourage central clearing in EU (e.g. by requiring EU clearing members and clients subject to the clearing obligation to hold active accounts with EU CCPs, the so-called active account requirement or AAR), strengthen the role of EU authorities, particularly the European and Securities Markets Authority (ESMA) in supervising EU CCPs, and improve the attractiveness of EU CCPs (e.g. by shortening and simplifying the approval process for new derivative products and services). The first two, the active accounts and supervision, were the big elephants in the room. On 13 February 2024, following negotiations and political agreement with the EU Parliament, the Council of the European Union released the final text of EMIR 3.0, which is expected to be published in the Official Journal pending Parliament’s approval.
It is very unlikely that EMIR 3.0 will fulfill the EU’s ambition. This is because Member States’ interest does not align with that of the EU. There are Member States that want to attract as much activity as possible to their local CCPs, and others that want to protect their clearing members (as relocating would cost money, bring less multi-netting benefits and put EU client clearing members at a competitive disadvantage to their non-EU peers). Trying to align these interests, in the absence of a quantitative cost-benefit analysis, is a challenging task. As a result, the final text maintains the Council’s less punitive approach of an operational active account with representativeness. It also introduces a requirement for financial counterparties and non-financial counterparties above certain minimal thresholds to hold an active account at an EU CCP and to clear several representative trades from that account.
The risk that active accounts pose, is to add costs to European firms, diminish their competitive position, lead EU clients who are not under the clearing obligations to use non-EU clearing members, and concentrate non-EU clients’ euro-denominated interest rate swaps (IRS) trading activity with non-EU dealers (this non-EU activity represents the majority of the EUR IRS market). Moreover, active accounts will result to the loss of netting benefit, the need to maintain margins at two CCPs, and set-up a management framework to deal with requirements for the compliance framework. This will put European firms at risk of simply becoming regional distributors for their global peers.
Regarding supervision, although the EP favours more centralised supervision for CCPs, the Council is resisting and wants to maintain the status quo. The Council’s view is that current supervision works well and that there is no need to give more powers to ESMA. The Council’s press release refers to strengthening ESMA’s role by providing it with a rather limited coordination role in emergency situations only. In addition, it highlights twice that ultimate decision-making powers are the responsibility of the national competent authorities (NCAs). This is similar to the CCP Recovery and Resolution Regulation, where the national resolution authorities, rather than ESMA, are in the driving seat. Given that the ultimate underwriting for any resolution costs also rests with the Member States, this is how Member States want to keep it. But for the Commission, maintaining the status quo is considered as a major collective failure. And this is exactly what EMIR 3.0 represents.
Over the last few years, the clearing industry has witnessed a string of market stress events that have exposed risks and weaknesses. But the storm was weathered, thanks to the industry’s flexibility and the swift action of some Member States to provide support to others. Despite this, the current supervisory structure revealed its weaknesses caused by being segregated (i.e. national versus the European interest). Europe, unfortunately, always has the tendency to leave some unfinished business behind, to be inflexible and extremely prescriptive in the way it legislates. Pushing more and more legislation into Level 1 adds to the complexity when circumstances change and require legislative adjustments. While the EU stood for a principles-based approach in the past, with mutual recognition, it is becoming more and more rules based.
If the ambition is to encourage clearing within EU CCPs and with EU clearing members, to reduce reliance on systemic non-EU CCPs, and to build a more attractive and robust EU clearing market, then there is the need for a centralised supervisory framework. Just enhancing the current supervision mechanism would not be enough. Moving away from a national approach to clearing supervision, but at the same time ensuring closer collaboration between NCAs and ESMA, would allow the risks associated with the interconnectedness of the EU financial system, as well as the increased clearing volumes and the growth of cross-border exposure to be sufficiently managed.
Having a European centralised supervisor will not only strengthen risk monitoring and (eventually) minimise systemic risks but would also reduce the costs of supervision, the number of procedures, the divergent interpretations of EMIR rules, and the exchange of data. ESMA should not only supervise Tier 2 third country CCPs, but also all major EU CCPs. The fundamental issue at stake is the fact that in the event of a CCP crisis the financial risks will ultimately lie with a Member State and cannot be shouldered by the industry or by ESMA. Any move towards centralised supervision cannot ignore this key point.
Going forward, Europe needs a framework that does not create obstacles (or at least minimises negative outcomes), as well as a workable setup with realistic processes and timelines (e.g. almost two years to approve new products in Europe compared to a shorter timeframe in other jurisdictions). Efficiency should not be undermined by complexity and burdensome requirements. Allowing for smooth cross-border transactions is crucial – the going concern for business is cross border, but a crisis is national.
The European Capital Markets Institute (ECMI) is an independent research institute run by the Centre for European Policy Studies (CEPS), an independent thinktank based in Brussels.Â
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