The Committee on Capital Markets Regulation today sent a letter to the European Commission and Commodity Futures Trading Commission (CFTC), detailing steps that each regulator must take before December 15, in order to avoid disrupting the $630 trillion derivatives market and substantially increasing the cost of hedging financial and commodity risks for U.S. and E.U. entities.

Unless the European Commission recognizes U.S. derivatives clearinghouses before December 15, E.U. legislation would effectively require E.U. banks and E.U. affiliates of U.S. banks clearing swaps or futures with U.S. clearinghouses to terminate these relationships.

“We cannot wait until December 14. The time for action is now. Derivative contracts hedge risk over several months, so counterparties will soon be unable to roll-over existing contracts,” explains Professor Hal S. Scott, Director of the Committee on Capital Markets Regulation.

To prevent this from occurring, the European Commission and the CFTC must recognize each other’s regulatory regime for derivatives clearinghouses as equivalent. These regulators have yet to reach an agreement, due to certain differences between E.U. and U.S. rules. These differences include initial margin for futures, segregation of customer collateral and bankruptcy laws.

“If the steps set forth in the letter are taken, then E.U.-U.S. clearinghouse recognition is possible, without any undue risk to financial stability. There is no need for an extremely costly disruption of the global derivatives market,” says Scott.

One issue that has received substantial attention is differences between E.U. and U.S. rules for initial margin for futures. However, outcomes-based analyses have demonstrated that the U.S. and E.U. rules result in broadly consistent customer margin levels. Thus, the European Commission and CFTC need not require line-by-line equivalence for initial margin rules. Such an approach would be consistent with a recommendation by G-20 derivatives regulators that substituted compliance for derivatives rules should be based on whether both regimes reach comparable regulatory outcomes.

For further details regarding resolution of other E.U.-U.S. differences, please see the letter below.

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The Committee on Capital Markets Regulation is an independent and nonpartisan 501(c)(3) research organization dedicated to improving the regulation of U.S. capital markets.

For further information:
Hal S. Scott, Director Committee on Capital Markets Regulation
hscott@law.harvard.edu
617.496.2217

View the letter here.