E.U.-U.S. Agreement on Equivalence for Central Clearing Parties: Building Cross-Border Harmony
By Willa Bruckner, Alston and Bird LLP
Despite the consensus reached over six years ago among G-20 regulators on general principles for derivatives regulation, implementation of those principles in cross-border contexts has not always been smooth. The difficulty was evident in the lengthy, often tense process leading up to the long-awaited agreement between European Union (E.U.) and United States (U.S.) regulators on central clearing party equivalence.
The agreement, announced last week, is a key step towards removing uncertainty surrounding the status of central clearing parties in one jurisdiction under the regulatory scheme of the other jurisdiction, which has plagued the market for some time. Cross-border regulatory uncertainty can lead to market fragmentation along jurisdictional lines, impacting liquidity and adversely affecting all market participants. Absent resolution of differences between the E.U. and U.S. regulators and removal of a primary hurdle for an equivalency determination, market participants would have to cover higher regulatory and compliance costs to avoid market fragmentation. That outcome is questionable, at best, in the long run.
Regulation of central clearing parties is a critical responsibility for regulators, and the related equivalency determination is not to be taken lightly. Central clearing has been set as a regulatory cornerstones for addressing systemic risk, and the financial crisis demonstrated that discounting systemic risk can have dire consequences in a global marketplace. Regulators are best positioned to address systemic risk. That responsibility cannot be left solely to sell side participants, who are focused on achieving acceptable profit levels while complying with complex and developing regulatory schemes, or to buy side participants, who are concerned about identifying the products and providers that best meet their trading, investment or hedging goals at an acceptable cost. Regulators in both the E.U. and the U.S. were right to consider deeply and carefully the appropriate regulation of central clearing parties. While some sectors of the market may not be fully satisfied with the details of the agreement between E.U. and U.S. regulators, most would agree that an equivalency determination is a positive development.
The process for determining and implementing central clearing party equivalence is not done, however. In the E.U., the matter must be put to a vote of the European Commission and, assuming it is adopted, central clearing parties based in the U.S. then need to be given recognition in the E.U. Similarly, the Commodity Futures Trading Commission (CFTC) must propose and agree that the regulatory schemes in the two jurisdictions are comparable and then consider and approve E.U. central clearing parties for registration in the U.S. Both E.U. regulators and the CFTC have indicated they will expedite the remaining steps in the process.
E.U. and U.S. regulators should make good on their public pronouncement and complete these next steps quickly and efficiently. The market would be best served if equivalency and recognition of central clearing parties are in place well before the E.U. clearing deadline that looms in June of this year. In addition to assuring an effective transition to clearing, completing these added steps quickly will build market confidence that resolution of differences between regulators inevitably arising over time will not take a toll on the smooth functioning of the market.
Willa Cohen Bruckner is a partner in the Financial Services & Products Group of Alston & Bird LLP.