New European capital rules to be delayed

The European Commission is set to delay the implementation of new European capital rules upon banks in Europe until 15 December 2016. The new rules are set to impose tougher capital requirements on banks using non-EU CCPs (central counterparty clearinghouses) that are not approved by European regulators.

This is the fourth such delay to the new rules. They were originally due to come into force on 15 June 2014, but were repeatedly delayed as negotiations dragged on over equivalence between the clearing rules in Europe and those laid out by the CFTC (Commodities Futures Trading Commission), the US regulator.

The EC and CFTC reached equivalence over their clearing rule earlier this year.

The US, however, has two derivatives regulators and the SEC (Securities Exchange Commission) regulates two of the US’s largest CCPs, DTCC and OCC.

If equivalence cannot be reached between the EC and the SEC, then European banks would face far higher capital charges for derivatives trades cleared at any venue operated by either of them. In a paper released last December, OCC estimated that European banks would need to hold an extra $5.25bn in capital against trades conducted at OCC if equivalence could not be found and the new European capital rules came into effect.

This could prove prohibitive to European banks doing business at OCC, which has a monopoly on clearing equity options in the US.

The EC rules state that a postponement to the implementation of its new rules can be brought about in exceptional circumstances and to avoid disruption to international financial markets. Whilst the circumstances are no longer exceptional, there is no doubting the disruption that the new rules would cause should they be implemented prior to equivalence being agreed by the EC and the SEC.

The same fears were raised by US CCPs during the protracted negotiations between the EC and the CFTC. CME publicly estimated that capital charges would go up 30 times from their then existing levels if their CCP was not recognised by EU regulators.

Accordingly, the new capital rules were continuously postponed whilst the delicate equivalency negotiations continued.

One sticking point for the EC and the SEC in their negotiations over equivalency is the fact that OCC, as things stand, is not in a position to meet the European clearing standards of maintaining a sufficient default fund to cover the default of its two largest Clearing Members, otherwise known as Cover 2.

OCC operates a Cover 1 model – it can withstand the default of its largest Clearing Member, but there are doubts, at least according to S&P, that it could withstand the default of its two largest Clearing Members. We looked at this more detail last week: Europe, clearing equivalence and the SEC

The CCPs regulated by the CFTC, such as CME and ICE, are all operating on Cover 2 and are recognised in Europe as Qualifying, or QCCPs.

The postponement of the capital rules in Europe gives OCC a further six months to rectify this, or at least to convince the regulators that it has access to sufficient credit and default fund contributions, should they be needed, to meet the Cover 2 standard.

Negotiations between the EC and SEC are ongoing, although they now have a little more time to reach an agreement. Given the importance of the outcome of these negotiations, it would be no surprise if there are more delays to the new European capital rules further down the line as well.

Tags: ClearingEquivalenceEuropean CommissionSECCFTC