On 10 February, the European Commission and the US Commodity Futures Trading Commission (CFTC) reached a long-awaited agreement regarding requirements for central clearing counterparties (CCPs). The agreement follows more than three years of discussion between the European Union and the United States and will help to harmonise regulation of the global derivatives market.

An important step

Jonathan Hill, Commissioner for Financial Services, Financial Stability and Capital Markets Union, called the deal 'an important step forward for global regulatory convergence,' adding that it will mean that 'European CCPs will be able to do business in the United States more easily and that US CCPs can continue to provide services to EU companies'.

The US and EU are home to the largest derivatives markets in the world, and, in 2013, together made up approximately 88% of the global turnover for interest rate swaps.  So establishing a common approach is critical to ensure that global derivatives markets can continue to prosper, while keeping the financial system as stable and resilient as possible. 'It is a significant milestone in harmonising regulation of these markets,' said CFTC Chairman Timothy Massad.  

Although the requirements for CCPs under both the EU and the CFTC's regimes are based on the same international principles, differences in the detail of implementing rules meant a thorough analysis was necessary before a final decision was made.

What are CCPs?

CCPs, sometimes known as clearing houses, enhance financial stability by guaranteeing the obligations of each counterparty to a transaction. Cleared transactions commonly include derivatives as well as other financial products such as bonds, equities and securities financing contracts. If a counterparty goes into default before settling its obligations, its other counterparties are protected by the financial resources held by the CCP.

Recognising the importance of CCPs in mitigating risks in the financial system, G20 leaders made a commitment in 2009 to mandate the use of CCPs for standard derivatives contracts. Both the CFTC and the EU have adopted rules to this effect, increasing the use of CCPs across EU and US markets.

Why is this agreement important?

Many derivatives transactions are carried out cross-border, with up to 40% of the global market in US dollar interest rate derivatives in 2014 being made up of transactions between EU and US banks. In order to ensure that cross-border activity can continue and that liquidity pools are not fragmented, EU and US market participants need mutual access to CCPs serving both jurisdictions. There are currently 4 EU CCPs operating under the CFTC's regime in the US, and 7 US CCPs registered under the CFTC's regime are seeking recognition in the EU.

As non-EU CCPs can only operate in the EU where an equivalence decision has been made, this decision is crucial to ensure that EU market participants can continue to use US CCPs.

What happens now?

The European Commission has now adopted an equivalence decision for the CFTC's regime. In order to reconcile a small number of differences between the US and the EU, the decision – which has been agreed upon by the European Securities committee – includes certain conditions that US CCPs must meet. ESMA will now complete the application process for the seven CCPs seeking recognition on the basis of the decision. The CFTC staff will propose a comparability determination, declaring that a majority of EU requirements are comparable to CFTC requirements.  This will enable EU CCPs to comply with EU rules instead of CFTC requirements when serving US markets. In addition to this, ESMA recently consulted on the possibility for EU CCPs to comply with standards similar to CFTC requirements in the area of client margins.

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