Clearing houses operating in the EU would be required to ring fence all collateral deposits linked to trades in products like FX swaps and forwards under proposals released by the EU’s European Securities and Markets Authority (ESMA) today.
The finalized ESMA guidelines on so-called central counterparty clearing (CCP) house interoperability would also require the companies – which are supported by clearing members that include all the leading global banks – to manage any legal risks related to the obligations of the CCPs to support one another in the event that one of the clearing houses defaults.
The guidelines also specify that the CCPs should work to ensure equal levels of access to market data for other CCPs that come under ESMA regulation in the future, that they share responsibility for guaranteeing the safety of the agency’s CCP cooperation guidelines going forward and that they work to include national-level regulators in all future interoperability arrangements.
At issue for the FX market though are the CCP interoperability arrangements for the ring-fencing of collateral.
Banking industry group the Global Financial Markets Association (GFMA) has long opposed ESMA’s collateral and margining mandates for FX swaps and forwards trades via the Basel III process on the grounds that enforcing the proposals would be counterproductive for the traded market.
GFMA maintains that FX swaps and forwards should not be subjected to international margining regimes that might distort the market.
In August, GFMA released comments submitted to the Bank of International Settlements – which oversees the Basel III implementation process globally – responding to a Basel Committee on Banking Supervision (BCBS) paper looking at the need to manage risks associated with the settlement of FX transactions.
The BCBS proposal would require that all uncleared derivatives under the EU’s European Market Infrastructure Regulation (EMIR) be subject to mandatory variable margin and initial margin across all product types, including FX.
Those BCBS standards were finalized in November.
In an interview with EuromoneyFXNews, GFMA global FX division managing director James Kemp – who authored his group’s comments on the BCBS paper – says it is important for the regulators managing the Basel process to realize that the key risk in FX is settlement risk.
GFMA says 94% of estimated maximum loss exposure in a trade for FX instruments with a maturity of six months or less is managed in a number of ways, chiefly by CLS.
The 6% of risk that the currency products pose to the stability of the FX market and the wider financial system is replacement risk, which Kemp says the industry manages through the increasing use of credit agreements called CSAs.
That risk expands to 11% as maturities on the deliverable FX swaps and forwards grow to one year.
“Having covered the key systemic risks, it is important to allow banks to take on well-managed risk to extend credit to fund economic growth,” says Kemp.
The closing date for responses to the finalized ESMA CCP interoperability guidelines is January 31, 2013.