The CFTC - EC CCP accord - what it means for hedge funds

The CFTC and the European Commission agreed on a framework to recognize each other’s clearinghouses, central clearing counter-parties (CCP’s), as subject to the same regulatory oversight. The question comment from many traders is likely to be, “So what”. Well, this is a big deal. If this was not done, then US clearinghouses would not be qualifying CCPs under EU law. The impact would be that European banks carrying positions there would be subject to a penalty capital charges.   

Now, under this agreement, the European Securities and Markets Authority (ESMA) can authorize a US derivative clearing organization (DCO) as an equivalent to an EU qualifying CCP for bank capital requirements. The equivalence will occur if the US DCO’s provide for three changes to make them similar to EU CCP’s.  European CCP will now have to meet all of the requirements of a derivative clearing organization (DCO). This goes a long way to standardizing regulation for CCPs around the world and will reduce regulatory uncertainty. Of course, greater standardization means that there will be less innovation of opportunity for new approaches to risk management.

Nevertheless, we believe that this accord will have a strong impact on futures customers and the result will not good. Costs will go up either through increases in margin required, shuffling of FCM players, or implicit expenses because the FCM will have higher costs. Having house accounts hold more margin will make being a prop trading clearing firm more expensive. It is not clear that holding two-day margin will protect the market in a crisis. There is also a carve-out for agricultural positions. Having more pro-cyclicality in margin models is not easy to solve except by raising margins. Forcing "cover 2" default resources means that DCOs will want to have less FCM concentration. They should want to make being large more expensive. More diversification of FCM is good but in the near-term smaller clients of the largest FCM may be at risk.

The law of unintended consequences will show itself as these rules are implemented.