Emir futures margin rules create 'regulatory arbitrage'

Clearing house and commodity traders voice concerns about European firms going to US due to Emir CCP standards

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Market participants warn higher margin requirements for commodity futures and options in the European Union (EU) could have the unwanted effect of creating regulatory arbitrage”, pushing the continent's commodity traders to move their activities to the US.

On December 19 last year, the European Commission adopted technical standards produced by the Paris-based European Securities and Markets Authority (Esma), which seek to implement parts of the European Market Infrastructure Regulation (Emir), including stricter standards for central counterparties (CCPs).

Among other things, the standards determine aspects of the margin methodology that should be used by CCPs clearing over-the-counter and exchange-traded derivatives. The standards say initial margin for any instruments that are not OTC derivatives should be calculated using a minimum two-day holding period – a figure that compares unfavourably with a one-day holding period permitted by the US Commodity Futures Trading Commission.

The holding period is an assumption about how swiftly a clearing house would be able to liquidate a portfolio belonging to a defaulted clearing member, which means longer holding periods can potentially create much higher initial margin demands.

According to participants at a Platts conference in London on May 14, the divergence could discourage firms from trading exchange-listed commodity products in Europe.

There is a lot of work to do in order to ensure that we have a multilateral international framework and not this kind of regulatory arbitrage

"This is not an arcane discussion – this is about actual access to markets. There are serious differences when you compare margining requirements, with the US on a one-day scenario, while Europe is stuck on two," said Mike Davis, London-based director of market development at Ice Futures Europe, the European futures unit of Atlanta-based Ice.

Compared with the amount that users of exchange-traded commodities are currently setting aside for initial margin, the Esma standards would increase the total by tens of billions of euros, claimed Davis. "That's additional cash the [regulators] simply want to have put up by companies for initial margin only and that is on the basis that it takes two days to liquidate a commodities position.”

While a two-day period might be necessary for other asset classes, such as credit default swaps, he said it was inappropriate for commodity futures and options, which are relatively vanilla and have well-correlated proxies in the OTC market.

Richard Baron, London-based European head of compliance at commodity trader Noble Group, said regulators needed to recognise the existence of a global capital market and avoid driving business elsewhere. "To the extent that you come out with some very cumbersome rules, there is quite a real risk – we've already seen it with a number of the trading houses – that they are considering or already have located to Switzerland or Asia. That is something regulators need to quite seriously bear in mind," he said.

Stéphane Graber, head of Swiss commodity trading association GTSA, said any potential differences between EU and US rules would make life more complicated for commodity traders. Regulators ought to focus on building more consistent global rules and preventing regulatory arbitrage, he said. "There is a lot of work to do in order to ensure that we have a multilateral international framework and not this kind of regulatory arbitrage.”

The fears about exchange-traded commodities are just the latest example of concerns about discrepancies in global rules that seek to ensure the safety of derivatives markets.

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