Europe's Plea for Derivatives Rules Delay Shows Risk of a Split

By Radi Khasawneh, TABB Group

Originally published on TABB Forum 

While the US and Europe agreed in July on a ‘Path Forward’ for derivatives reform, European Commissioner Michel Barnier’s request for a delay in the implementation of US rules raises the risk of a breakdown in regulatory harmonization. 

Summer is well and truly over, and with the arrival of autumn has come a distinct change of tone on European/US cooperation on the cross-border application of derivatives regulation.

Michel Barnier, the European Commissioner in charge of markets, on Monday wrote to the head of the Commodity Futures Trading Commission, Gary Gensler. Barnier asked for a five-month delay in the implementation of US derivatives trading regulations, particularly the Swap Execution Facility (SEF) registration requirements, to avoid a fragmentation of the liquidity pool. In this case, there is no real need to look below the surface for a motive – what Barnier needs is simply the time for Europe to finalize crucial details in its own approach to derivatives reform. After all, it is very difficult to negotiate on cross-border application without a clear idea of where you stand.

The European Markets Infrastructure Regulation (EMIR), already in force, has not been applied because the final clearing and trade reporting technical standards have yet to be decided. Even more important, participants such as trade repositories have yet to be approved by the regulator. That is before you even get to the fact that the accompanying Markets in Financial Instruments Directive II package of reforms has not been finalized. The devil is in the details, and it is the details that are much harder to agree on in Europe’s balkanized system. Clear answers to the questions of which swaps are covered under the clearing mandate and whether equities will be traded on new organized trading facilities are still up in the air. 

That is the reason for the change in tone from the much-heralded agreement between Barnier and Gensler in July, called the “Path Forward.” The language then was much more positive, with the US agreeing to grant no-action relief for European entities such as clearinghouses in anticipation of parallel regulations in Europe, so-called “equivalence.” One swallow does not a summer make, however, and even then there was an indication that a disparity in the timelines was causing an issue.

“As a result of the joint collaborative effort, in many places, final rules are essentially identical, even though the regulatory calendars are not always synchronized,” the July joint statement diplomatically put it.

To hold the US regime up as a paragon of regulatory certainty and timelines is a bit odd given the fiscal cliff shutdown, but the timing of Barnier’s plea may not be an accident. The famous Footnote 88 of the final Swap Execution Facility (SEF) rules caused a flurry of activity ahead of the Oct. 2 deadline for SEF registration. The footnote specified that all multi-lateral trading (including foreign exchange) must take place on a registered SEF. That meant some institutions had to change plans and set up SEFs, and early indications are that the non-US entities that Barnier was most concerned about are those that have had the most trouble getting up to speed.

Even with all this going on, the latest indications are that the US will stick with its deadlines, and with the progress already made on clearing, it’s ahead of the game. That is a crucial advantage in the talks with Europe on cross-border application, because US regulators can point to a (hopefully) working marketplace and infrastructure.

Europe’s timeline creep, meanwhile, continues. The latest change from the European Securities and Markets Authority was announced on Sept. 26, one day after the regulator was set to publish technical standards for cross-border application of EMIR. It extended its own deadline to Nov. 15, in order to “fully analyze” the responses to its public consultation.

It has been very encouraging for some market participants to see European regulators taking their views on board and tangibly having an effect on the process, but Europe now risks hobbling itself. The CFTC may well come to the view that a five-month delay would give no guarantee of any clarity at that point.