The European Union’s decision to postpone collateral rules for swaps is putting pressure on U.S. regulators to follow suit to avoid rupturing the $493 trillion market dominated by the world’s biggest banks.
The European Commission, the EU’s executive arm, said last week it won’t be able to meet a September deadline set by the U.S.—and laid out as goal by global regulators—for standards that seek to ensure banks have sufficient collateral to backstop transactions done directly with other traders. Europe plans to complete the regulations by year-end, though they may not take effect until mid-2017, according to the commission in Brussels.
The timing gap threatens to raise competitive pressures, since U.S. banks will need to comply with the rules starting in September, possibly affecting billions of dollars in collateral. This divergence could discourage trading between U.S. and European banks in the interim and make it more expensive for U.S. banks.
“Reports of a delay in Europe’s margin rules appear to be the chickens coming home to roost,” said J. Christopher Giancarlo, a Republican member of the U.S. Commodity Futures Trading Commission. “As I have said time and time again, our failure to properly coordinate with the rest of the world will result in regulatory arbitrage that will only serve to harm American markets.”
The delay is the latest rift between the U.S. and Europe on oversight of the swaps market, one of the most global markets with large traders active in both jurisdictions. Regulators moved after the 2008 credit crisis to beef up oversight. One of the key regulations was designed to ensure over-the-counter trades have sufficient collateral to protect against the threat that one side defaults.
The collateral standards were the subject of extensive international discussions over the last few years, with two groups of banking and market regulators consulting on how best to coordinate the rules. The Basel Committee on Banking Supervision and the International Organization of Securities Commissions ran the effort and set the September deadline.
The chairmen of the U.S. House and Senate committees that oversee the CFTC, the top U.S. derivatives regulator, said they were concerned by the gap between the U.S. and Europe timelines and the harm that might cause for U.S. firms.
“This is yet another failure of international cooperation which will have real consequences for U.S. market participants,” K. Michael Conaway, a Texas Republican and chairman of the House panel, said in a statement. Pat Roberts, the Kansas Republican who leads the Senate committee, said: “We do not need a different set of rules or time frames that put U.S. firms at a disadvantage. I will be looking into this in more detail.”
The U.S. Treasury Department took an active role in calling for global standards on collateral, with Timothy Geithner, the former secretary, saying in 2011 that coordination was essential to “prevent regulatory arbitrage and a ‘race to the bottom.”’
The U.S. and Europe are the largest jurisdictions for trading in the over-the-counter derivatives market, estimated at $493 trillion by the Bank for International Settlements. The market is dominated by the biggest banks, which often trade with each other to hedge risks they’re exposed to through trades with their clients.
The European delay has also prompted calls for the U.S. to follow suit.
“I suspect U.S. entities would feel hard done by if they had to collect initial margin at a time when their EU counterparts didn’t,” said Deepak Sitlani, a partner at Linklaters law firm in London. “The question now is whether there will be some sort of relief under the U.S. rules.”
Emma Dwyer, a partner at law firm Allen & Overy in London, said the split raises questions about how the industry will comply.
“Without the same delay on a global basis market participants will be left grappling with how to implement rules in a piecemeal manner,” Dwyer said. “Frankly it’s a mess unless the U.S. and everyone else delays too.”
U.S. rules require banks to exchange two types of collateral with other banks and with other clients for non-centrally cleared trades. Starting Sept. 1, large banks trading with each other will need to exchange initial margin, collateral at the outset of a trade, as well as variation margin, which is already a common market practice to offset risks during the life of the trade. At the beginning of March 2017, the U.S. rules require banks also to exchange variation margin when they trade with a wider range of clients.
“The anti-competitive impact would be especially severe if timing differences stretch past March 2017 when variation margin is to apply market-wide,” Colin Lloyd, a partner at Cleary Gottlieb Steen & Hamilton LLP in New York, said by email.
So far, the CFTC is sticking to the deadline. “I wouldn’t expect us to delay,” Timothy Massad, chairman of the regulator, told reporters in New York last week. “Everybody’s been moving toward Sept. 1. It’s still a good date.”
A trade association for big money managers said regulators need to coordinate the timing of their standards because of the international scope of the swaps market and to ensure there is enough time for traders to meet the requirements.
“A harmonized phase-in will reduce market disruptions and disparate pricing that would harm investors,” said Laura Martin, managing director and associate general counsel of the asset management group of the Securities Industry and Financial Markets Association.
Paul Andrews, the secretary general of IOSCO, said in a speech in London last week that regulators were wrestling with details in the margin standards even before the delay in Europe. Andrews said IOSCO, whose members include the CFTC and U.K. Financial Conduct Authority, plans to publish additional guidance by the end of the year.
“I don’t think by Sept. 1 we are going to have all of these issues resolved,” Andrews said. “It has turned out to be a lot more complicated than I think any of us imagined.”