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ESMA throws in the equivalence towel

ESMA has today published a consultation paper seeking to cut through the Gordian knot of EU-US CCP equivalence. On Friday 11 December 2015, the Commission approved the fourth extension of the QCCP deadline to 15 June 2016. The major bone of contention between regulators of the world’s two largest derivatives trading blocs has been the minimum liquidation period applied by CCPs in collateral calculations.

The US futures market uses a one day period without netting across a clearing member’s clients, EMIR Article 26 (1)(b) stipulates a minimum period of two days although this is nettable. ESMA calculates that a one day period results in margin calls that are 41% lower than those derived from a two-day method. If the US were to be judged equivalent while retaining such a large discrepancy, EU clients would naturally choose to deal almost exclusively through US CCPs. ESMA’s proposal is therefore to amend the RTS to allow CCPs to offer both a two-day net and a one-day gross account structure. However, this is a gift horse whose teeth need close examination- the one day option includes intraday margining and that the identity of the clients is known to the CCP. ESMA suggest that mandatory intraday margin is based on real time portfolio monitoring and intraday price updates, subject to as yet undecided materiality threshold. ESMA recommends that ISA account structures should also be made available on the one-day minimum format. In the interests of harmonisation, it is recommended that the one-day option applies to both ETD and OTC markets.

This is a clever proposal by ESMA, while many questions remain as to the operational viability of intraday margining, particularly in respect of ISA structures, it is likely to be vital first hole in the equivalency dyke.  Equally, there are many reasons, beside the purely operational, why both CMs and clients may wish to retain the choice of a two-day net period. The important debate as to relative reduction in systemic risk afforded by the two options is far from over, even if this CP makes it increasingly academic. The consultation remains open until 1 February 2016, following which ESMA will decide whether to deliver a final report to the Commission amending the draft RTS, the odds are overwhelmingly likely that it will.

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