On June 6, the Futures Industry Association (FIA) published a letter addressed to European Commission (EC) Vice–President Valdis Dombrovskis, detailing its concerns about the potential approach of forced relocation of euro-denominated derivatives clearing to the European Union. Forced relocation was raised as an option for ensuring the protection of the financial stability and monetary policy of the European Union in the EC’s May 2017 communication on certain challenges for critical financial market infrastructures and for further developing the Capital Markets Union.
FIA states that relocation would be the most disruptive and expensive approach to overseeing third-country central counter-parties (CCPs), without improving the oversight of this activity. It opposes relocation for the effects it will have on the derivatives markets, including:
- Fragmentation. FIA states that fragmentation of the market would result in the creation of two distinct pools of trading liquidity, one offshore with the majority of euro-denominated swaps traded by foreign institutions and a smaller and less-liquid on-shore pool for swaps traded by EU institutions. This small pool could impact a CCP’s ability to successfully port or auction client positions of a defaulting clearing member and increase systemic risk.
- Weakening the stability of the EU. FIA points out that a key part of promoting financial stability through the use of CCPs is having a significant pool of clearing members available to accept clients or positions from a defaulting clearing member. As well as the already-declining number of clearing firms, a location policy could increase concerns around the market’s ability to absorb clients of a defaulting clearing member.
- Costs for end-users. FIA believes that the fragmentation of clearing among multiple CCPs would reduce the benefits of portfolio margining; risk offsets would be lost and end users would have to post more margin to accommodate this heightened risk, estimated to be as much as an additional $77 billion. End users would also face higher execution costs due to lower volumes and a reduced number of market participants.
FIA instead supports the EC’s use of recognition and enhanced supervision as being a more effective and less disruptive way to protect financial stability. They note that the European Union has been a leader in developing “equivalence” regimes for third countries, which have the ability to raise standards to meet those of the European Union. The letter ends by recognizing that further enhancements between EU and UK supervisory authorities may be needed after Brexit, but that history has shown that a location policy is not needed to meet their intended regulatory objectives.
The letter is available here.