On March 22, the Securities and Exchange Commission approved a rule that will shorten the standard settlement cycle for most securities transactions to T+2 from T+3. Broker-dealers will be required to comply with the shorter settlement cycle beginning on Sept. 5.
“Transition to a T+2 settlement cycle will reduce by one business day the time horizon for risk exposures as well as for potential liquidity pressures, which should yield other benefits for market participants and the clearance and settlement infrastructure as a whole,” Michael Piwowar, the SEC’s acting chairman, said in a statement.
The main impact for derivatives market participants will be on exercises and assignments for equity options. To help market participants prepare, the OCC, the clearinghouse for U.S. equity options exchanges, has set up a schedule of tests taking place over the next several months.
Fintech in Focus
Quebec’s financial regulator, the Autorité des Marchés Financiers, has created an internal think tank to explore applications of new technologies among the entities it regulates, including exchanges and clearinghouses, as well as potential applications to its own regulatory activities.
The AMF also said it intends to form partnerships with key players in the financial sector and academia, and announced the signing of a partnership agreement with R3, an innovation firm focused on building platforms and applications for the financial sector. R3 has established a consortium of financial institutions for developing and applying blockchain technology in the financial services industry.
The think tank, which the AMF is calling its “Fintech Lab,” will also serve as a talent incubator, drawing on university students in engineering and technology as interns under the supervision of members of AMF’s fintech working group.
The AMF said the lab will focus on four objectives: deepen and update the AMF’s knowledge of new technologies; explore how the AMF itself can better use new technologies to improve its business processes; provide advice and insight with respect to a review of the regulatory framework and to the regulatory sandbox initiatives implemented by the Canadian Securities Administrators; and anticipate the AMF’s needs regarding the latest expertise and computer systems.
In January, the Commodity Futures Trading Commission issued a proposal to update and modernize Rule 1.31, which sets out certain recordkeeping requirements for futures commission merchants, commodity pool operators, trading firms that are exchange members, and other market participants.
On March 20, FIA filed a comment letter broadly supporting the proposal, welcoming the agency’s “technology neutral and principles-based” approach and its effort to remove outdated and irrelevant provisions. FIA recommended a handful of further refinements to the rule, and encouraged the CFTC to work with the Securities and Exchange Commission to harmonize relevant rules for FCMs and broker-dealers.
Cloud Over London
On May 4, the European Commission issued a policy statement discussing its plans to issue legislative proposals by the end of June to address “important and emerging challenges” in derivatives clearing.
The statement indicated that these proposals may include a requirement that the clearing of euro-denominated derivatives take place within the European Union, which would have the effect of forcing this business out of London after the U.K. leaves the EU. The policy statement held out the possibility, however, that “enhanced supervisory arrangements” would be sufficient.
The Commission observed that clearing services are concentrated in a limited number of clearinghouses, increasing their importance to financial stability and market functioning well beyond their home country. For this reason, there is a need to enhance the current supervisory arrangements, which tend to rely on home state supervision.
“In this context, the foreseen withdrawal of the United Kingdom from the EU will have a significant impact on the regulation and supervision of clearing in Europe,” the Commission said. “At present, as much as 75% of euro-denominated interest rate derivatives are cleared in the U.K. Derivatives denominated in some other Member States’ currencies are also cleared in the U.K. These transactions directly impact the responsibilities, including in the area of monetary policy, of the relevant EU and Member State institutions and authorities.”
On May 4, the European Commission published a legislative text proposing changes to the European Market Infrastructure Regulation. The proposed changes, if approved, would ease certain requirements related to derivatives clearing and transaction reporting and reduce costs and regulatory burdens for market participants.
Valdis Dombrovskis, the commissioner in charge of financial services policy, emphasized that the majority of the changes come as a result of the Commission’s call for evidence, which sought views from the industry on where post-crisis legislation could be amended to streamline existing provisions and reduce unintended consequences.
“The European Market Infrastructure Regulation is at the heart of the EU’s financial reforms,” Dombrovskis said. “Today’s proposal ensures that EMIR achieves its objective of reducing systemic risk in the OTC derivatives market, while keeping costs to a minimum for the real economy. The proposal builds on the Commission’s call for evidence and deepens our capital markets and our efforts to support investment, growth and jobs.” Key elements of the May 4 legislative proposal include the following:
• Streamlined reporting of exchange-traded derivatives: Under EMIR, transactions in exchange-traded derivatives must be reported by both sides of the transaction. The proposal introduces single-sided reporting for exchange-traded derivatives and assigns the reporting responsibility to clearinghouses. The Commission said this will “greatly simplify” the reporting process without adversely impacting transparency.
• Removal of frontloading and backloading requirements: The proposal would remove the obligation to report historic data on OTC derivatives trades, known as “backloading.” The Commission believes that this will significantly reduce costs and burdens on counterparties and result only in a very limited loss of data compared to the current rules. In addition, the frontloading requirement also would be removed. Under the current rules, long-dated trades must be reported as soon as they become subject to mandatory clearing requirements, even if the clearing obligation has not taken effect.
• Intra-group exemption: Intragroup transactions involving non-financial counterparties would be exempted from the reporting obligation. The Commission said this would significantly reduce the costs and burdens of reporting for these counterparties without significantly affecting the ability of regulators to monitor systemic risk in the OTC derivative markets.
• Temporary suspension of the clearing obligation: The proposal would give the Commission the power to temporarily suspend any clearing obligation on the basis of a request from the European Securities and Markets Authority. The Commission explained that this power is needed if the clearing obligation becomes impossible to continue or has adverse effects for financial stability. The Commission also noted that this new provision complements the proposed framework for the recovery and resolution of central counterparties by introducing the mechanism for a temporary suspension of clearing obligation in situations other than resolution.
• CCP transparency: The proposal would require central counterparties to provide their members with tools allowing them to simulate the amount of collateral requested to clear future trades. In addition, CCPs would be required to make available a thorough description of their initial margin models to their clearing members for them to gain a clear understanding of their reach and their limitations.
• Clearing obligation for non-financial counterparties: Contracts by non-financial firms above a clearing threshold will continue to have to be cleared through a CCP. However, the proposed amendments would allow firms to only clear those classes of derivatives which breach the clearing threshold. In addition, only non-hedging contracts would be counted towards thresholds triggering the clearing obligation.
• Clearing obligation for pension funds: The proposal would extend by three years the temporary exemption from the clearing obligation of pension scheme arrangements. Clearing obligation for small financial counterparties: The proposal would establish a clearing threshold for small financial counterparties based on the volume of their OTC derivatives transactions. Only counterparties exceeding that threshold would be required to clear their trades.
Competition in Clearing
On March 29, the European Commission issued a statement prohibiting the proposed merger between Deutsche Börse and London Stock Exchange Group. The Commission concluded that the merger would have created a de facto monopoly in the clearing of fixed income instruments.
“The merger between Deutsche Börse and the London Stock Exchange would have significantly reduced competition by creating a de facto monopoly in the crucial area of clearing of fixed income instruments. As the parties failed to offer the remedies required to address our competition concerns, the Commission has decided to prohibit the merger,” said Commissioner Margrethe Vestager, who is in charge of competition policy.
LSE had proposed divesting LCH.Clearnet SA, its Paris-based clearinghouse, to remedy the Commission’s concerns. While the EC concluded that this divestment would have resolved the concerns relating to single stock equity derivatives, it said the divestment would not have been effective to remedy the impact on fixed income clearing.
“Deutsche Börse is well-positioned on a stand-alone basis to compete at a global level with other market infrastructure players,” Carsten Kengeter, CEO of Deutsche Börse, said in a statement. “We will continue to pursue our growth strategy, to strengthen our innovation capabilities and to even better serve market and customer needs,” he said.