US asset managers have begun re-papering legal agreements with their bank clearing providers as they lose faith that US and European regulators will reach an agreement to recognise each other’s clearing regimes before European rules go live.
Market participants had taken US and European regulators at their word when they pledged to end a long-running cross-jurisdictional spat over the efficacy of each other’s derivatives clearing frameworks – but trust appears to be running thin as the date for mandatory clearing in Europe is only four months away.
“In a Pollyannaish way we tried to assume regulators would come to an agreement – but the clock is ticking and the deadline is approaching,” said William Thum, principal in the legal department at Vanguard, on a panel at the FIA-SIFMA Asset Manager Derivatives Forum in California.
“We don’t have a choice but to face the reality that if we don’t have everything set up [for the European model] in just a few months we could be locked out of European markets.”
Many US asset managers are now asking bank clearing providers to fit the existing European model where it appears their funds will fall under EU rules.
Such a situation was considered absurd at the outset of the regulatory disagreement, which began almost two years ago. Participants presumed the battle was political in nature and that petty differences would be set aside.
As the deadline for European mandatory clearing approaches, however, so too does the expectation that US and European regulators will operate different clearing frameworks and will not recognise each other’s rules as sufficient and substitutable for compliance purposes.
“It’s hard when you’re pushing for rational behaviour and that’s what you’re banking on but you’re just not getting it,” said Amy Koch Flynn, managing director and global head of trading at Standish Asset Management, speaking on the panel.
“It’s becoming really difficult to prepare for two different regimes – and having to deal with this issue doesn’t seem like it’s something we should be wasting our time on right now.”
Margin disagreement
The stumbling block is the methodology used to calculate the amount of collateral required to back those swaps. US regulators have implemented a one-day gross margin model, while European regulators favour a two-day net model that they claim leads to higher levels of collateral backing trades at clearinghouses.
Market participants say the difference is minimal and point out that the two sides have recognised each other’s margin methodologies for years. The European Commission has already approved less established clearing frameworks from countries such as South Korea, Mexico, and South Africa, but refused to recognise the US until an agreement on margin methodology is reached.
Swaps clearing becomes mandatory in Europe on June 21, which represents a dead-end for equivalence to be achieved ahead of the live-date as there are no extensions available to the European Commission.
Many view the drawn-out negotiations as purely political. The European Commission took a hardline stance two years ago when then-Commissioner Michel Barnier expressed frustration at a perceived snub by then-CFTC Chairman Gary Gensler.
Others believe it is simply stubbornness on the part of US regulators, who may be refusing to make minor tweaks that would make the disharmony disappear.
CFTC chairman Timothy Massad and Jonathan Hill, Commissioner for financial services at the EC, have layered goodwill into public speeches and projected confidence for an agreement that they have so far failed to deliver.
The European Commission has a history of cutting its decisions fine, having waited until the eleventh hour three times to extend a deadline that would have seen US participants cut off from clearing in European markets.