Brian Quintenz, a Republican commissioner on the Commodity Futures Trading Commission (CFC), has committed to voting against EU equivalence determinations, a critical part of the post-crisis regulatory understanding between the European Union and the US.
“At this point, I see no reason for the CFTC to further pursue any cross-border harmonisation with the EU,” he said, adding that the White House, US Treasury Dept and senior US senators were all in opposition to the European Commission proposal.
The strong words from the commissioner were both unsurprising and largely justified in trying to force Europe to engage with the CFTC over the important issue of clearing supervision.
The European Commission’s June proposal includes a clause that allows European bodies to remove recognition of foreign clearing houses — in essence forcing them to relocate to the continent to offer their clearing services. It also significantly ups the stringency of oversight by bodies like ESMA, the pan-European securities watchdog.
To say the CFTC is not happy with the new proposals is an understatement. Both the CFTC chairman, Christopher Giancarlo, and other commissioners have dismissed the proposal as a Brexit issue that should not be affecting the US.
The discussion is particularly pertinent in the wake of an equivalence agreement signed by the European Commission and the CFTC in 2016.
The agreement means that regulators from both jurisdictions respect each other's ability to police their own derivatives clearing markets so that they can minimise duplication of oversight.
Changing the way foreign clearing houses are regulated by the EU is unlikely to sit well with this understanding.
Tunnel vision
While Quintenz caveated his speech in Florida by saying it only represented his own views, it is easy to imagine that his colleagues feel just as strongly about the situation as he does.
As GlobalCapital noted in a previous opinion piece, Giancarlo has backed the 2016 equivalence agreement on several occasions, claiming that going back on the agreement by changing clearing supervision arrangements would be akin to a “violation of trust”.
Central clearing of derivatives has become more and more important as the months have gone by, and post-crisis regulation pushes more derivatives to CCPs. This means the 2016 agreement cannot be guaranteed to last unchanged forever.
But the apparent tunnel vision from the European side is plain to all. Public statements and responses to the CFTC’s concerns are in short supply.
In fact, while a speech by Mario Draghi last month seemed to address US concerns by stealth, it is very difficult to recall times when top European authorities have properly acknowledged the CFTC’s worries, still less expressed an intention to work through those issues.
All the while, resentment has been building in Washington DC. Anger over the EC’s stance on derivatives clearing has become one of those rare issues that gets bipartisan support in Congress.
In a pickle
The CFTC’s aversion to the new proposal puts the EC in a pickle. The proposal is still a work in progress, but under the working draft, some US CCPs would almost certainly be marked as “tier 2”, and thus subject to increased oversight not agreed to by the US in 2016.
But if the EC wants its proposal to be taken seriously, it will want to preserve the hopefully impartial decisionmaking process as to which CCPs should be more stringently regulated. Until now, this has been based on “objective criteria or thresholds” in relation to the systemic importance of the CCP to the EU’s economy.
Narrowing down increased regulatory oversight to just London, or even London Stock Exchange Group’s LCH, could mean that the proposal is not taken seriously. Many who GlobalCapital spoke to have expressed serious reservations about the proposal and focussing on London would not help the EC’s rhetoric, which suggests the rule changes are about better calibrating post-crisis regulation.
On the other hand, some sort of special exemption for just the US in the spirit of the 2016 equivalence agreement could be worked out. But again, leaving the world's largest derivatives market untouched in proposals which are meant to be aimed at third country CCPs generally, does not look very good for the European Commission. It could even anger other countries in which euro derivatives are cleared.
A third option would be for the EC to stay its course and plough ahead with its proposals, dealing with the fallout as it comes. This seems unlikely but could cause serious damage to the industry as the CFTC retaliates in kind.
In the long run, divergence on policy and day-to-day oversight will leave both regulators and the industry worse off.
But no matter what happens next, European officials have been wrong to let the issue fester for so long, and they might well find that they are now dealing with a CFTC that is far less open to compromise than just a few months ago.