CCP Access Structures

The obligatory clearing of certain contracts through CCPs, that is imposed by Regulation (EU) no. 648/2012 of 4 July 2012 on OTC derivatives, central counterparties and trade repositories (called “EMIR”, i.e. European Market Infrastructure Regulation), is justified by the need to increase the transparency of the derivatives market, to mitigate systemic risk and to promote stability of the financial system. Central counterparties (CCPs) are clearing houses that interpose themselves between the counterparties to the contracts traded on one or more financial markets, becoming the buyer to every seller and the seller to every buyer. In this way CCPs are responsible for the clearing of transactions concluded on derivatives market, which reduces the credit risk of individual counterparties. The EU legislator creates a legal framework for the functioning of CCPs that become new systemically important institutions. In addition, EMIR leads to the creation of a kind of monopoly as CCPs’ services become compulsory for entities involved in trading on financial instruments that will be subject to central clearing. For these reasons, EMIR represents new and difficult challenges for effective oversight and supervision of financial markets. The tendency to maintain a market structure where operate only a relatively limited number of CCPs is likely to be perpetuated due to the predominance of entities with established market position, as well as the presence of high sunk costs associated with the rigorous regulatory requirements that determine the possibility of entering the market. The regulation of financial market infrastructure has to take into consideration and to integrate two perspectives: micro (transaction costs) and macro (systemic risk).

This chapter assesses the international policy debate on insolvency management in relation to central counterparties (CCPs), as well as the general context in the European regulatory framework for the licensing and ongoing regulation of CCPs. It then turns to a closer examination of the new Regulation, which has been strongly influenced by the Financial Stability Board’s (FSB) ‘Key Attributes of Effective Insolvency Regimes for Financial Institutions’ of 2014, but is far more detailed and prescriptive. While the prudential requirements for CCPs’ own risk mitigation and loss management arrangements established under the European Market Infrastructure Regulation (EMIR) have been taken as the basis for recovery measures, the Regulation introduces some key features of recovery and resolution regimes for banking institutions also in relation to CCPs. Just as banks, CCP operators, under the Regulation, will be required to engage in rigorous recovery planning, while resolution authorities are required, in turn, to develop resolution plans in order to prepare for future contingencies. For the actual resolution stage, the Regulation prescribes a number of statutory tools, some of which have also been adapted from the corresponding regime for failing banks.

Central counterparties (CCPs) are an essential part of the global financial system. This chapter charts and reflects on trends affecting the regulation and supervision of CCPs. It pays particular attention to ‘global’ CCPs that must operate in a divided regulatory and supervisory space. In this context, this chapter examines deference arrangements - especially those recently adopted by the CFTC in the US and those enacted in the European Market Infrastructure Regulation, as amended - and asks whether deference is the answer to regulating/supervising global CCPs. This chapter will argue that there are good reasons in theory to think that full deference is not the answer, although in practice deference arrangements continue to prove popular as a pragmatic means to deal with the complexities of regulating/supervising global CCPs.

This panel was held on Monday, January 28, 2013, at the ASF 2013 conference. Panelists discussed the developing impact of swap regulation on securitization and what it means for the ability to use swaps in securitization as new regulations take effect. The Dodd–Frank Act added a definition of the term “commodity pool,” and the Commodity Exchange Act revised the definition of the term “commodity pool operator.” As a result, many securitizations that held swaps, often solely to hedge interest rate or currency mismatches between their assets and their liabilities, were at risk of being considered commodity pools. By the time the panel took place, however, the Commodities Futures Trading Commission had granted two significant pieces of interpretive guidance and no-action relief that together excluded most traditional securitizations (e.g., credit card or auto loan securitizations), most asset-backed commercial paper programs, many CLOs and CDOs (collateralized loan obligations and collateralized debt obligations), and most covered bond transactions from the definition of a commodity pool. The panel focused on the relief that was granted and the issues that remained to be resolved. The panel also discussed the aspects of entering a swap that would be different for a securitization now than it would have been a year ago. The most significant changes have not yet become effective. Those include clearing and margin requirements and, eventually, a requirement to transact on a designated contract market or swap execution facility if the swap has been “made available to trade” on such a facility. One of the cornerstones of Dodd–Frank’s swap regulations is the requirement that swaps be cleared through a central counterparty. Whether a swap will need to be cleared depends on the identities of the counterparties, the nature of the swap, and whether a derivatives clearing organization is willing to clear it. Even if a swap is not required to be cleared, it may still be subject to margin requirements and margin calls. <b>TOPICS:</b>Interest-rate and currency swaps, credit default swaps

This chapter provides an introduction to over-the-counter (OTC) derivatives clearing documentation. It sets out an overview of the legal framework and key concepts underpinning OTC clearing and discusses the supporting documentation. These include the central counterparty (CCP) rules, the International Swaps and Derivatives Association/Futures Industry Association (ISDA/FIA) Cleared Derivatives Execution Agreement, the ISDA/FIA Client Cleared OTC Derivatives Addendum, the FIA Clearing Module, collateral documentation, and related legal opinions. The chapter also examines considerations arising from regulatory obligations and other developments, some of which may also give rise to documentation requirements. These include the European Market Infrastructure Regulation (EMIR) Art. 39(7) disclosure requirements; the Markets in Financial Instruments Directive II (MiFID II), and the Markets in Financial Instruments Regulation (MiFIR) Model Provisions for the Addendum; EMIR requirements to provide clearing services under fair, reasonable, non-discriminatory, and transparent (FRANDT) commercial terms; and changes to CCP rules.

One of the arguments given in favor of the creation of the Commodity Futures Trading Commission (CFTC) in 1974 was the need to extend regulation to previously unregulated commodities. Under the CFTC's predecessor, the USDA Commodity Exchange Authority, futures markets for such international commodities as coffee, cocoa, sugar, and the metals had been largely unregulated. The argument in favor of increased regulation for these markets was parity-all U.S. futures markets should be treated alike. In arguing against increased regulation, domestic exchanges trading futures contracts on international commodities stated that federal regulation would drive business to competitive markets overseas, where traders were unfettered by regulations which required filing reports on their positions and trading. In fact, a representative for three exchanges claimed that if any of the bills calling for the creation of the CFTC were passed, the three exchanges would go out of business in four or five years (Chapin, p. 472). More recently, the argument has been reversed. One of the reasons given for the rapid growth of U.S. futures markets compared to British markets is the greater investor protection in U.S. markets because of federal regulation (Hewson, p. 14). In addition, new legislation and/or regulatory bodies for futures markets are being considered in Canada, England, France, and Australia. The purpose of this paper is to consider the competitive effects of market regulation. Briefly, we will describe regulatory differences between U.S. and British futures markets and then, using intervention analysis, examine the level of activity on competing U.S. and British futures markets for cocoa, coffee, and sugar during the period 1970 to the present to see if important regulatory changes affect the volume of trading on these markets. Testimony provided to a Senate committee by the CFTC indicates that in the United States foreign traders make up a sizable proportion of all futures traders holding reportable positions in these commodities. The data revealed that about 30% of the long side and 45% of the short side of the total open interest in these commodities on 24 May 1983 was held by reportable foreign traders (Phillips). Commercial multinational firms are the predominant users of these futures markets. They are highly sophisticated traders who follow international prices and government policies closely and are experienced in dealing with foreign trade risks. As a result, it is assumed that they could shift their futures trading from one market to another if they wished to avoid regulation they considered too burdensome. It should also be noted that in addition to regulation, a number of other factors affect a trader's choice of futures markets, including exchange rate risk and foreign exchange controls, futures contract differences, taxation, and international and national commodity programs. This brief paper, however, does not allow us to consider these factors.

Towards the end of 2009, the regulatory authorities unexpectedly blocked plans by UK, Dutch and Swiss-based central counterparties (CCPs) to interoperate. They feared that linking multiple CCPs together would create a significant risk to the wider financial system. In a joint letter, the regulators outlined their position on interoperability, in an effort to allay fears about systemic risks and inject fresh competition into the market. This statement was the first sign of how regulators believed the process of ‘interoperability’ could move ahead. The new approach — published high-level in the joint letter — has been agreed by market authorities in conjunction with the European Commission. Although the main pan-European CCPs expressed their support for the proposed framework and their intention to work to establish a model that mitigates any additional risks likely to be introduced in compliance with the new requirements, there is still little sign of early consensus. The differences in thinking between firms are so ingrained that without the regulators taking a more prescriptive line there is a risk that interoperability is simply not going to happen. A new regulation, informally referred to as European Market Infrastructure Legislation (EMIL), is expected to materialise in 2010 and will enter into force in 2012. It is likely to regulate the way CCPs operate. CCP inter­operability for cash equities will potentially be included. In a recently published Discussion Paper, the European Commission said that a future legislative framework may need to take an explicit stance on some of the issues currently under consideration. This could include: the options for managing inter-CCP exposures that are currently under consideration; issues related to rehypothecation; and requesting that relevant competent authorities/ESMA determine whether the risk parameters of the CCPs are compatible with interoperability operating in a safe manner prior to coming into effect.

The over-the-counter (OTC) derivatives market has captured the attention of regulators after the Global Financial Crisis due to the risk it poses to financial stability. Under the post-crisis regulatory reform the concentration of business, and risks, among a few major players is changed by the concentration of a large portion of transactions in the new market infrastructures, the Central Counterparties (CCPs). This book, for the first time, analyses the regulatory response of the United Kingdom and the United States, the two largest centres of OTC derivatives transactions, and highlights their shortcomings. The book uses a normative risk-based approach to regulation as a methodological lens to analyse the UK regime of CCPs in the OTC derivatives market. It specifically focuses on prudential supervision and conduct of business rules governing OTC derivatives transactions and the move towards enhancing the use of central clearing. The resulting analysis, from a normative risk based approach, suggests that the UK regime for CCPs does not fulfil what would be expected if a coherent risk based approach was taken. Our comments on the Dodd-Frank Act highlight that the incoherent adoption of risk-based approach to regulation affects the effectiveness of the US regime for CCPs. Such a regime does not follow the pace of events of 'innovation risk'; in particular, the foreseeable changes FinTech will bring to the OTCDM and central clearing services. The second inadequacy of the US regime concerns the dual regulatory structure of the CFTC and the SEC, and the inadequate adoption of different and not well-coordinated regulatory strategies. We also analyse the cross-border implications of the US regime for non-US CCPs that provide clearing services to US market participants. Finally, we study the negative effects of the absence of a clearly defined resolution regime for CCPs.

The Commodity Futures Trading Commission (CFTC) is an independent agency with exclusive jurisdiction over futures trading in all commodities. The Commodity Exchange Act of 1936 (CEA) set forth the first federal regulatory framework for futures trading in agricultural commodities. In 1974, Congress passed the Commodity Futures Trading Commission Act, overhauling the CEA and establishing the CFTC. When President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law, the CFTC was a natural regulatory authority for the implementation of Dodd-Frank because of its historical role in regulating a remote corner of the derivatives market place (i.e., futures). This chapter discusses the role of the CFTC, its structure, disciplinary action, and its regulatory background.

Clearing forms the core part of a smooth and efficiently functioning financial market infrastructure. Traditionally, it has been provided by clearing houses, most of which today act as a 'central counterparty' (CCP) between the two sides of a trade. The rapid growth of cross-border trading has sparked discussion on the most efficient industry structure - particularly in Europe and the US. At the heart of this discussion lies the question of whether the implementation of a single clearing house creates greater benefits than a more competitive but interlinked market structure. This is the starting point for this book, which analyses the efficiency of clearing and clearing industry structure. Along with clear-cut definitions and a concise characterisation and descriptive analysis of the clearing industry, the book determines the efficiency impact of various cross-border integration and harmonisation initiatives between CCPs. This serves to identify the most preferable future structure for the clearing industry.

Central Counterparties’ Insolvency and Resolution – The New EU Regulation on CCP Recovery and Resolution

This chapter provides some background information on the regulation of clearing houses, that emerged as a topical issue in the aftermath of the financial crisis of 2008. After a brief introduction, the chapter elaborates on the definition of market infrastructure, clearing houses, and clearing, while taking into consideration their pros and cons from different perspectives. It also provides an analysis of the general framework of the European Market Infrastructure Regulation (EMIR). Focusing on its main provisions applicable to clearing houses, it emphasizes those related to their authorization, corporate governance, and prudential requirements. The chapter provides some critical considerations of these aspects from an international perspective.

Students are asked to evaluate the merits of a lawsuit that agricultural producers filed, along with the U.S. Commodity Futures Trading Commission (CFTC), against their marketing advisory service. The lawsuit was motivated by apparent losses in their commodity accounts allegedly caused by speculative trading.

The Fatal Flaw of Proposals to Federalize Insurance

Over the past several months, the price of oil has declined precipitously. From a high of $145 per barrel in July of 2008, the price of oil has now declined to below $50 per barrel at the time of this writing. The correlation with the performance of the Canadian market has been striking. Current news reports focus on the decline in Canadian securities performance as a reflection of weakness in the oil market. Given the cyclical nature of the securities market and the commodities market, questions arise as to whether the price of oil has reached its nadir and whether the current environment represents an opportunity to purchase oil-based products as part of a value-accretion strategy. How is oil traded Oil is is regulated by the Commodity Futures Trading Commission and is usually bought as a derivative product. In most cases, oil is purchased as a future contract. This contract entitles the purchaser to buy the security at a future date at a specified price. It is typically traded by two broad classes of investors. The largest class has interests in the oil industry. They are trading as a hedge against price fluctuations. Airlines, manufacturers and others who use oil as a factor of production use such contracts as a means of providing predictable supply at predictable prices. The second class of individuals who purchase such contracts are speculators who seek to profit from fluctuations in market price. In most cases, such speculation is confined to the contracts themselves and no delivery is taken of the commodity. How is the price of oil determined? There are three primary factors that influence the price of oil. The first is market demand. Energy demand is often conceived as a proxy for economic and manufacturing activity within the economies of various countries. Aggregate output has begun to slow worldwide. While gross domestic products continue to rise slowly, the rapid growth witnessed in some countries has slowed. This has been especially true in China, where demand for oil has plateaued. As economic growth has been curtailed, the effect is a reduction in demand for energy and for oil. In more developed countries, there has been a shift toward alternative energy production, thus decreasing demand for carbon-based energy. Such reduction in demand has a negative effect on price. Supply is the second determining factor. Supply is often determined by the cost of production in the short and long term. The cost of production varies depending on the cost of extraction and processing. The cheapest cost of production is in Saudi Arabia and Libya, where production can be as low as $5 per barrel. However, production costs reach a zenith of $90 per barrel in some oil sands developments. In the short term, supply can be adjusted to reflect immediate demand. However, this becomes more complicated in the long term. Decisions regarding infrastructure are made in anticipation of future prices. Once committed, much of this infrastructure is built regardless of the current price. Decisions regarding operations occur at the margins, thus promoting production once large capital costs have been incurred. The overall effect has been a significant increase in supply. Large investments in infrastructure have been made by ‘fracking’ firms. Fracking in the United States has significantly increased the supply of domestic oil. While the United States does not export oil to any significant degree, it has curtailed its import as the result of domestic production. Supply has also expanded as the result of geopolitical factors. The current conflicts in Iraq and Libya have not curtailed production to the extent expected, thus increasing global supply. Finally, there has been no move by the Organization of the Petroleum Exporting Countries to reduce production by its members to stabilize price. They are continuing to produce in an effort to maintain market share. The cumulative effect has been a highly significant increase in supply. The third ingredient is deemed by most experts to be market sentiment. As the name implies, there is very little certainty associated with these fluctuations. While market fundamentals may be held constant, in some circumstances, volatility may result from increased speculation and macroeconomic predictions. The source and result of these sentimental shifts remains elusive and exceedingly difficult to predict.