The Commodity Futures Trading Commission has approved a substituted compliance framework for dually-registered central counterparties, located in both the U.S. and European Union. It was accompanied by a comparability determination with respect to certain EU rules. European CCPs registered with the CFTC can now comply with its rules by meeting corresponding European Market Infrastructure Regulation requirements.
The action follows what the agency describes as an “historic agreement” between the CFTC and the European Commission regarding dually-registered derivatives clearing organizations “and represents a major step in paving the way for the EU’s recognition of U.S. CCPs.”
“The equivalence agreement announced by European Commissioner Jonathan Hill and myself is an important step in achieving cross-border harmonization of derivatives regulation,” CFTC Chairman Timothy Massad said in a statement. “The Substituted Compliance Determination provides a foundation for cooperation among regulators in the oversight of the global clearinghouses that are so important in our financial system today. It resolves the issues that were standing in the way of Europe recognizing U.S. CCPs and it helps make sure that the U.S. and European derivatives markets can continue to be dynamic, with robust competition and liquidity across borders.”
In February, after three years of hammering out a new “common approach” for central clearing counterparties with European officials, the CFTC reached agreement with the European Commission on a framework to recognize that the other continent’s clearinghouses are subject to equivalent regulatory oversight. CCPs guarantee the obligations of all counterparties to a transaction, typically with high-quality asset holdings. If a counterparty to a transaction goes into default before settling its obligations, its other counterparties are protected by collateral held by the CCP that is calculated and collected on a daily basis.
Without such a determination, a U.S. clearinghouse could not be deemed a “qualifying CCP” under EU law and European banks carrying positions here would be subject to penalty capital charges. As part of the agreement, domestic clearinghouses seeking recognition in the EU must demonstrate compliance with new requirements that are not currently required for all U.S. CCPs, including collecting initial margins sufficient to cover a two-day liquidation process and sufficient resources to cover the default of the two members with the largest exposure to them. The margins requirement will not apply to domestically traded agriculture derivatives.
Steps to implementing the common approach included having the CFTC finalize a substituted compliance regime for EU CCPs, the EC adopting an equivalence decision, and an authorizing vote by EU member states.
With the latest step in that process, on March 16, the CFTC determined that certain laws and regulations applicable in the EU provide a sufficient basis for regulatory comparability.
The Substituted Compliance Determination, published in the Federal Register and effective upon that publication, follows extensive analysis by the CFTC and EC to understand whether differences in their regulatory regimes were significant. The framework identifies EMIR requirements that are comparable to the corresponding CFTC requirements and further harmonizes the CFTC and EMIR regimes “without risking regulatory arbitrage while also enhancing the protection of customers.”
“The agreement reached between the EC and the CFTC avoids unacceptable changes to four decades of U.S. clearinghouse margin policy and higher costs of hedging risk for America’s farmers, ranchers, financial institutions, energy firms and manufacturers,” CFTC Commissioner J. Christopher Giancarlo said in a statement. Giancarlo had been critical of “the protracted process” for reaching the compromise, one “made needlessly complex because both the EC and the CFTC insisted on a line-by-line rule analysis contrary to the flexible, outcomes-based approach advocated by the OTC Derivatives Regulators Group.”
“While the end result is a good one, the approach taken to get here was needlessly circuitous and uncertain,” he said. “The CFTC and its global counterparts must now recommit themselves to work together to implement an equivalence and substituted compliance process, particularly for swaps execution and the cross-border activities of swap dealers and major swaps participants, based on common principles in order to increase regulatory harmonization and reduce market balkanization. The future of the global swaps marketplace depends on it.”