Clearers challenge Massad over EU client protections

Market participants have challenged CFTC chairman Timothy Massad's suggestion that Europe's CCP margin rules put customers at greater risk

Commingling only a problem in theory, say European CCPs

Clearing banks and central counterparties (CCPs) have challenged a top US regulator's suggestion that European clearing rules put customers at greater risk.

Timothy Massad, chairman of the Commodity Futures Trading Commission (CFTC), drew attention to what he called "a difference in the treatment of house affiliates" under European rules at the European Parliament, where he delivered a speech on margin methodologies for CCPs last month. Affiliates, in this context, are the other legal entities of a CCP member – the 'house' – that execute cleared trades.

"We require that affiliate transactions be in the house account so they don't jeopardise customers. Europe allows affiliates to be treated as customers," he said.

The implication is that client assets at a European CCP may be at risk in the event a clearing member defaults, because of the potential commingling of client assets with those of a clearing member's affiliates.

European CCPs and clearing banks say this is only a theoretical problem – four banks that spoke to Risk say they are not aware of any institution operating so-called omnibus accounts in which customers and affiliates are both present, although the European Market Infrastructure Regulation (Emir) does allow it.

The charge by the CFTC remains a theoretical possibility, if not actually borne out by reality

"What is true is that there are differences in how affiliates are treated under US regulations versus EU regulations. But that doesn't mean affiliates have to be commingled with clients in Europe, which is what the CFTC's argument implies. It is possible to have two client omnibus accounts – one for affiliates and one for clients – thus avoiding the commingling effect and at the same time satisfying the Emir requirements," says a senior clearing executive at one European bank.

A London-based lawyer who advises banks and CCPs also dismisses the CFTC's inference that clearing banks in Europe are commingling client and affiliate positions in the same margin accounts, calling it "a theoretical possibility" that is "not actually borne out by reality".

European and US regulators are trying to resolve a dispute over which jurisdiction has the most conservative set of clearing rules. Europe has yet to deem the US framework equivalent to its own, which is holding up authorisation of US CCPs – a necessary step for banks that use these clearing houses to obtain lower capital charges.

Massad used his appearance at the European Parliament to argue the US regime is stronger in terms of margin required – the focal point of the dispute to this point – but his comments about segregation introduced a further point of difference.

Article 39 of Emir, which governs the segregation of cleared positions, requires a clearing member to "offer its clients, at least, the choice between omnibus client segregation and individual client segregation". The omnibus option allows collateral to be pooled with that of other clients – reducing the net margin requirement for the pool – while individual segregation gives a client its own account.

The US rules mandate an approach known as legal segregation with operational commingling (Lsoc), which is supposed to deliver the same protections as a segregated account but allows for positions to be commingled in practice.

The London-based lawyer says he is not aware of any banks that commingle their affiliate and client positions in the same omnibus account, but he does not rule out the possibility that some clearing firms may do so.

"Under the EU regime, clearing members are required to treat anyone other than themselves as clients. As a result, affiliates can be seen as clients," he says. "However, any client in an individual segregated account will not be commingled. The issue could come up with omnibus accounts, but it is up to the clearing member to determine whether it opens up an omnibus solely for its affiliates and a separate one for its clients, or whether it runs only one omnibus account for all concerned.

"I have not heard of anyone taking that approach," he adds. "However, the charge by the CFTC remains a theoretical possibility, if not actually borne out by reality."

The banks that spoke to Risk for this article all insisted they use different accounts for affiliates and clients, even when customers opt for an omnibus account.

The head of a European CCP in London also says he is not aware of any clearing members commingling client and affiliate positions in the same margin accounts.

A senior clearing expert at another European bank backs that up, and counters that individual segregation actually offers greater protection than the US Lsoc approach.

"US representatives always talk as if there wasn't any choice for customers other than being in the net omnibus under Emir. However, Emir mandates that clearing brokers have to offer at least a fully segregated account for their clients. Clients have a choice to go above what Lsoc in the US offers if they want to," he says.