EU members of US options CCP face $30bn capital hit

OCC fears approval will be held up by absence of SEC clearing rules

SEC: clearing rules were proposed 18 months ago

A new wrinkle in the transatlantic dispute over clearing house regulation could leave 18 European banks facing an estimated $30 billion jump in capital requirements, and limit access to equity options listed in the US.

The unlucky 18 are members of the Options Clearing Corporation (OCC), a US clearing house that is regulated by both the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC). Because the SEC has not yet finalised its clearing house rules, it is not clear how European authorities can judge the OCC's supervisory regime to be equal to Europe's own – the first step in the approvals process for any foreign clearing house. If European clearing members continue using non-approved clearing houses after mid-2016, they will face big capital increases.

"If the current transitional period expires and we are not yet recognised – and those 18 members were to continue to clear through OCC – based on our evaluation their capital charges would increase in aggregate by slightly less than $30 billion," says Joe Kamnik, general counsel at OCC. "Our members tell us they would have to refresh their analysis on whether it's cost-effective to stay in the game."

The OCC's European members include Barclays, BNP Paribas, Deutsche Bank, Societe Generale, UBS and other major banks.

European regulators have until June 15, 2016 to recognise overseas central counterparties (CCPs), a deadline that has been pushed back four times while the European Commission tries to reach an agreement with the CFTC over the latter's rules.

Equivalence has already been granted to nine jurisdictions, but securities and futures regulation is split in the US, with the SEC overseeing securities – and their associated derivatives – while the CFTC is responsible for other listed and over-the-counter derivatives. A CCP with products in both camps must register as a clearing agency under the Securities Exchange Act, and a derivatives clearing organisation under the Commodities Exchange Act.

The threat to dual-regulated clearing houses is not widely recognised. None of the six lawyers contacted by for this article were aware of the issue.

"The SEC has not promulgated any enforceable rules on security-based swaps yet and there is nothing expected until 2016. The CFTC is clearly the centre of attention," says a Washington, DC-based partner at a US law firm.

The approval process in Europe has two steps: first, the EC must adopt an implementing act determining that the legal and supervisory arrangements of a third country ensure its CCPs comply with legally binding requirements equivalent to those laid out by the European Market Infrastructure Regulation. Only after this can the European Securities and Markets Authority (Esma) recognise an overseas CCP. Trades handled by these qualifying CCPs are granted rock-bottom risk weights by Europe's version of Basel III.

The problem is that although the OCC is dually regulated, its sole supervisory agency is the SEC – and it is understood the EC is considering granting equivalence separately for the two US agencies' regimes, so instead of finding the US equivalent, it would reach an equivalency decision for the CFTC's rules only.

"We have good reason to believe Esma would not recognise CCPs in the US operating under the SEC regulatory regime without a prior equivalency determination for the SEC, irrespective of the progress with the CFTC," says one industry source who has been following the issue.

Four other US CCPs are dually regulated, but in practice the OCC is a special case as it is the only CCP also to have the SEC as its supervisory agency, and clear securities products. CME Group and Ice are also regulated by both the SEC and the CFTC, but CME is not currently clearing securities products, and Ice's supervisory agency is the CFTC. The other two CCPs are the Depository Trust Company and the National Securities Clearing Corporation, which are registered solely with the SEC.

"We're unique in that approximately 97% of our business is on the securities side, and just a sliver is on the CFTC side," says Kamnik. "It's also worth pointing out we're the only options clearing house for US listed options in the world; there's no other CCP banks can port their business to. In other asset classes there are natural competitor CCPs, so if one is not recognised you can port to another one to avoid a charge. But for US listed options clearing you cannot do that."

The OCC cleared a total of 362.1 million contracts in October, for 17 options exchanges and futures markets, including the Chicago Board Options Exchange, Bats Options Market, Nasdaq Futures and the International Securities Exchange.

The latest delay of Europe's equivalence deadline gives the SEC more time to complete its rules, but there is no indication of when the rules will be finalised. Known as the Standards for Covered Clearing Agencies, the rules were first proposed on March 12, 2014 with comments due by May 27, 2014. There has been no update since.

"It's really not clear why it's taking the SEC this amount of time," says the OCC's Kamnik. "As we are a regulated entity with the SEC, we have natural contact with the regulators and we use every reasonable opportunity to address this point with them. We talk to them about this with regularity, but the European regulators are a little harder as we don't have a nexus of regulatory connection."

The potential capital hit for OCC members is a consequence of the Capital Requirements Regulation (CRR), which states that European banks – whether acting through their branch or subsidiary – will only be given a 2% risk weight for cleared trades if using a so-called qualifying CCP following expiration of the current extended grandfathering period. Clearing at a non-QCCP can translate to risk weights of more than 1,250%. The new weights were originally due to take effect from September 15, 2013, but the slow pace of equivalence rulings has seen the grandfathering period extended four times.

The latest expiration date for that relief is June 15, 2016, which could roughly coincide with the start of mandatory clearing under the European Market Infrastructure Regulation.

The recognition deadline impacts both the grandfathering period under CRR and the list of venues open to European clearing members, which are only allowed to use QCCPs. If the OCC does not have QCCP status when the deadline expires, existing European clearing members could continue using the venue – and therefore trading US listed options – but only as clients of other members, and only through a foreign subsidiary that is not guaranteed by the European parent.

A London-based partner at another large US law firm says the jump in costs would force European banks to stop using non-QCCP venues altogether.

"It's correct that European members' only option would be to stop clearing at non-QCCPs. If that's where the market is currently clearing those transactions in the US then it will cause problems in the EU. The SEC has had so many other things to focus on. Reform under Dodd-Frank for over-the-counter derivatives is their lowest priority. They're very far behind," she says.

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