Derivatives regulation pact agreed between US and Europe

Regulators in the US and Europe have reached an agreement regarding the $553 trillion derivatives market, something which looks set to bring great relief to financial institutions.

The Commodity Futures Trading Commission and the European Commission have both agreed to a set of requirements which will regulate derivatives clearinghouses. It is hoped that these regulations will ease constraints relating to capital for banks that clear derivatives trades through major banks such as the Atlanta-based Intercontinental Exchange.

The agreement is welcome news for many large clearinghouses and banks, which had looked certain to fall victim to the threat of higher costs alongside disrupted trading.

Announced late last week, the agreement is still awaiting the final approval in both Europe and the US. If given the green light, it would bring to a close three years of discussions and disagreements over how to arrange a common set of regulations that were capable of boosting the stability across the global financial marketplaces.

In the years since the world-wide financial crisis in 2008, regulators overseeing the financial sphere have been calling for further interest-rate swaps and a range of other derivatives to be cleared not through private buyer-seller arrangements but through clearinghouses. These clearinghouses act as a go-between for banks and other buyers and sellers of derivatives and futures. Many organisations make use of these institutions to try to mitigate the risk of shifts in interest rates, global currencies and commodity prices. Clearinghouses aim to lower the risk element by ensuring that both the buyer and seller on either side of the transaction posts collateral.

However, while it seems both the US and Europe were in agreement about the need for such clearinghouses, the two locales were unable to agree on each other’s regulations that governed the sphere. Without this agreement in place, banks across Europe were being forced to pay far higher capital requirements in order to clear trades through American clearinghouses. This meant that the clearing of derivatives by European banks in the US was also at risk of failing.

The agreement appears to be positive news on all counts for the market as a whole. Indeed, treasury secretary, Jacob J. Lew, released a statement which said that the new agreement was a “major milestone” for the global derivatives market going forward.

“Finding common ground with our European partners to establish a level playing field internationally will help support cross-border activity with the appropriate regulation and supervision,” added Mr Lew.

The European commissioner for financial stability, financial services and capital markets union, Jonathan Hill, was reported as saying in the New York Times: “After more than three years of discussion, we are now able to provide certainty for the marketplace.”

Many financial experts believed that, without the cross-border agreement, there could have well been a disastrous fragmentation of the financial marketplace. Willa Cohen Bruckner, partner in the financial services and products group at the law firm of the New York-based Alston & Bird LLP, told Pensions and Investments: that, without an agreement between the US and Europe, “there would be fewer available central clearing entities, or some central clearing entities would be available only at higher costs. The agreement is a necessary step toward assuring the market can continue to operate as a global market.”

According to FIA, the futures industry trade association confirmed that it believed the US-based clearinghouses to be performing under the equivalence rules by 21 June this year. This date would mean that the US houses were able to meet the European deadline governing the moving of swaps-clearing to clearinghouses.

The FIA confirmed that European regulators would take steps to recognize US-based clearinghouses as being equivalent to their own regulated markets. They are due to vote on the move later this month, the body went on to say.

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