QCCP Status - The Race, the Chase, and the Wait
By Xiang Li, Thomas Murray
Originally published on TABB Forum
The Race – authorities fired the starting gun five years ago
Six months after the European Commission extended the transitional period, the deadline is looming again for a Central Counterparty to be classed as a QCCP (Qualifying CCP), which means it is licensed to operate as a CCP in European Union. The Dec. 15, 2014, deadline is almost upon us, as stipulated under Article 497 of the Capital Requirements Regulation (CRR), which comes into effect that day. There are discussions regarding what might happen when the transitional relief period runs out; there could be knock-on consequences for the capital that clearing members are required to hold.
EU-based clearing houses have had to present their credentials to ESMA for reauthorisation to operate as a QCCP. Clearing houses outside the EU wishing to maintain existing business relationships within the EU have been required to submit applications to be recognised by ESMA.
There is a link between the Q status and reauthorisation/recognition under EMIR, the European Market Infrastructure Regulation. The Basel III capital requirements for bank exposures mean that the Q clearing houses must: (i) be regulated according to the Principles for Financial Market Infrastructures; (ii) make available the calculation of hypothetical capital (KCCP), the prefunded default fund contributions from all clearing members (DFCM), and the CCP’s own contributions to the default fund (DFCCP) in order to enable a clearing member to calculate its capital requirement and; (iii) be licensed to operate as a CCP.
Requirement (iii), in Europe, comes in the form of reauthorisation by ESMA. CRR defines a QCCP as a central counterparty that has been either reauthorised or recognised under EMIR. This implies that ESMA would take (i) and (ii) into consideration and its authorisation or recognition is effectively a ‘QCCP licence’ in the EU.
This is the race CCP operators have been running for several years now, with those hurdles to jump. I hope you are following this so far...
The clearing houses are chasing the Q. Here is what they are running from: When the CRR provisions come into effect on Dec. 15, 2014, the capital for exposures to a non-QCCP will be prohibitively high, to the point that clearing members may even withdraw their membership.
In addition to ESMA authorising CCPs within Europe, the European Commission must assess whether clearing houses outside the EU operate under “equivalent regulatory regimes.” Failure by the EC to recognise a third country’s regulatory regime as equivalent will mean that ESMA cannot assess a third-country CCP application for recognition as a QCCP, which will have the same impact on a non-QCCP anywhere in terms of European-based clearing members’ capital costs. It will not matter if the clearing bank is a branch of a European organisation or a locally incorporated subsidiary. The difference in capital costs will be devastating.
The chase has required considerable administrative and organisational running and jumping. In September 2013, NASDAQ OMX Clearing was split off into a separate legal entity from its exchange owner as part of its EMIR compliance obligations. The regulation requires a CCP to have its own legal structure. Legal separation could ring-fence the risks and enable various stakeholders to analyse the capital adequacy of the CCP in a transparent manner. The Spanish CCP, BME Clearing, also became independent from its exchange.
Asset safety is another area that has seen significant changes. All EU-based CCPs are obliged to at least offer the option of individual segregation of client assets. This is widely viewed as the safest and clearest way to manage, but it is costly and may take a long time to implement. The EU CCPs had no choice if they wanted to stay in the game. For example, CC&G in Italy announced its plan to construct the EMIR-compliant account structure in June 2013, and then spent almost a year in implementation and testing.
For clearing houses outside Europe that realised at the last minute that they had to obtain EU recognition, it was quite a rush to submit their application by September last year. According to the list published by ESMA, most of the major CCPs outside the EU have sent in their documents. For many of them, the “Q” is forcing them to observe the Principles for Financial Market Infrastructures before their local regulator requires them to do so. Similarly to their European counterparts, these other clearers are undergoing a variety of changes to adapt to the new regulatory landscape, such as refining margin methodology, introducing “skin-in-the game” by putting their own money at risk, boosting their capital base, eliminating low-quality collateral, etc.
These intertwined regulations – EMIR, CRR, Basel III, PFMIs and the others – are laying a considerable burden on these market infrastructures. The positive side is that those CCPs that reacted swiftly and wisely in their chase for “Q” are becoming stronger and more robust.
I hope that you are still following this story …
For some, the race is over. The following European-based CCPs have been reauthorised by ESMA:
- NASDAQ OMX Clearing AB (18 March 2014)
- European Central Counterparty N.V. (1 April 2014)
- KDPW_CCP (8 April 2014)
- Eurex Clearing (10 April 2014)
- Cassa di Compensazione e Garanzia S.p.A. (CC&G) (20 May 2014)
- LCH.Clearnet SA (22 May 2014)
- European Commodity Clearing (11 June 2014)
- LCH.Clearnet Ltd (12 June 2014)
- Keler_CCP (4 July 2014)
- CME Clearing Europe Ltd (4 August 2014)
- CCP Austria (CCP.A) (14 August 2014)
- LME Clear Ltd (3 September 2014)
- BME Clearing (16 September 2014)
The major name missing on the list is ICE Clear Europe, the UK-based CCP that is supervised by the Bank of England. On Oct. 7, 2014, ICE Clear Europe issued a circular amending its rules and procedures, with many to become applicable upon receiving reauthorisation from ESMA. In a related Financial Times article on Oct. 10, 2014, it was reported that ICE Clear Europe has resubmitted its EMIR-application to the Bank of England and expects to receive its authorisation and Q at the end of the year, or early in 2015.
There was little news in relation to non-EU clearing house recognition until Oct. 30. In a statement on June 27, 2014, European Union Commissioner Michel Barnier stated his intentions to “shortly” propose the adoption of equivalence decisions for five jurisdictions, namely Japan, Singapore, Australia, Hong Kong and India. However, when the first four jurisdictions were announced to be “equivalent” on Oct. 30, 2014, India was left out. Since the primary condition of recognition has been met, that of the jurisdiction itself, the prospect of the CCPs in these four jurisdictions being treated as QCCPs by means of ESMA recognition is bright. Given that less than two months remain until the deadline, it is unclear what is occurring in relation to the other applications. Might they perhaps all be recognised all in one go? We wait.
At an FIA conference in Geneva on Sept. 23, 2014, Martin Merlin of the Commission’s Directorate for Internal Market and Services, remarked that: “The commission is considering a further six month extension of the deadline.”
It is unclear when this six month extension would begin because, according to the CRR Article 497:
“The Commission (EC) may adopt an implementing act under Article 5 of Regulation (EU) No. 182/2011 extending the transitional provisions in paragraphs 1 and 2 of this Article by a further six months, in exceptional circumstances where it is necessary and proportionate to avoid disruption to international financial markets.”
The extension resulted in the latest deadline of Dec. 15. As far as we read it, the regulation currently does not provide any additional provisions for extensions in exceptional circumstances.
The only extension that may be possible is the three-month provision that permits clearing members to treat a CCP as a QCCP following the end of the transitional period, or if the CCP no longer meets the criteria to be classed as a QCCP. This was clarified in a European Banking Authority (EBA) Q&A. In this situation for both European and TC-CCPs that have not been authorisation and/or received recognition, respectively, they can be treated as a QCCP until March 15, 2015, the purpose of the extra months being to enable clearing members to leave in an orderly fashion. In addition, theoretically it would also provide the regulators with extra time to authorise/recognise a CCP. Beyond this date, it is unclear where any additional time for any further administrative purpose could be found.
The main objective now is to ensure that CCPs are authorised and recognised pursuant to EMIR as soon as possible in order to prevent the derivatives market from becoming fragmented, a concern that was highlighted by the Managed Funds Association (MFA) in response to an ESMA consultation paper on the clearing obligation under EMIR.
What we do not know is how EMIR and its effects fit into the regulatory changes underway in other jurisdictions. In particular, the lack of recognition of the US market would cut off European banks from major US derivative markets.
And so after the race and the chase, we wait.