Are NDFs next? OTC Subject Matter Expert, Sol Steinberg offers an update on what’s shaking in the CCP clearing landscape for derivatives.
After 30 years of working for Congress and the federal government, John Riley recently stepped down from his position as Legislative Affairs Director at the Commodity Futures Trading Commission (CFTC). Ted Serafini, a two-year CFTC veteran who previously worked in the office of Acting Chairman Mark Wetjen, now serves as acting director of legislative affairs. Serafini and the rest of the CFTC will certainly have their work cut out for them, as the Commission has a very full agenda in the weeks and months ahead.
One of those agenda items is the establishment of a new advisory committee. In addition to examining systemic risk issues, the new Market Risk Advisory Committee will study “the impact and implications of an evolving market structure and movement of risk across clearinghouses, intermediaries, market makers and end-users.” The 20- to 25-person committee will include derivative and market experts, who will use their experience and research to advise the Commission on “how to improve market structure and mitigate risk.”
Meanwhile, the Commission is also contemplating the formation of a new clearing requirement for certain non-deliverable forwards (NDFs), which are an important segment of the foreign exchange (FX) market. According to Commissioner O’Malia, a proposal is currently being drafted that would require additional capital and post initial margin be held against non-centrally cleared derivatives. To ease the transition, the CFTC will establish a framework for “phased-in compliance” similar to the approach that was employed with interest rate swaps and credit default swaps. However, O’Malia cautioned market participants that “they should prepare for a quick transition to mandatory Swap Execution Facility (SEF) trading after the clearing requirement takes effect.”
As the leader in NDF clearing with $58 billion in notional value outstanding across 11 currencies at the end of March, LCH.Clearnet, through its ForexClear service, would feel the biggest impact from the new requirement. CME Group and Hong Kong Exchanges and Clearing (HKEx) also clear NDFs in multiple currencies.
International Flavor
In a related matter, HKEx is now able to offer clearing for interest rate swaps and NDFs to U.S. clearing participants without registering as a designated clearing organization with the CFTC. The new clearing services for client trades will be offered through OTC Clearing Hong Kong, which is currently limited to dealer-to-dealer trades. HKEx will permit the Hong Kong branches of U.S. banks to become clearing members in connection with their proprietary clearing businesses.
Looking toward Europe, Commissioner O’Malia recently sent an open letter to Michel Barnier, the European Union’s Commissioner for Internal Market and Services. The letter focused on next month’s deadline for higher capital standards on all third country CCPs (central counterparties) that are not recognized under European Market Infrastructure Regulation (EMIR). O’Malia expressed “significant concern” that none of the more than 33 non-EU CCPs that filed for recognition last September have been granted (Qualified Central Counterparty (QCCP) status.
Without recognition, U.S. CCPs will be unable to maintain direct clearing member relationships with EU firms. They will also be ineligible to clear contracts subject to the EU clearing mandate next year. O’Malia warned, “These scenarios would be detrimental to both U.S. and EU interests by leading to market fragmentation and contraction of liquidity.” He also expressed concern regarding the potential for “market disruption and dislocation due to the international nature of the swaps market and the prohibitive cost for EU banks to clear through third country CCPs” if the situation is not remedied.
Taking a firm stance, O’Malia reminded Barnier of the EU’s commitments to reduce risk and promote transparency in the OTC derivatives markets in order to monitor systemic risk and prevent another great financial crisis. He urged Barnier to devote his attention to this important issue. No doubt this issue will be discussed at the May 21 meeting of the Commission’s Global Markets Advisory Committee. The primary topic of the day-long public meeting will be coordination between the CFTC and foreign regulators, particularly oversight of non-U.S. clearinghouses and swap trading venues.
Elsewhere in the EU, the European Securities and Markets Authority (ESMA) appears a bit concerned over the implementation of mandatory clearing throughout its member countries. Fearful that uncertainty in the clearing process could cause “adverse impacts on risk hedging and financial stability,” ESMA intends to ease certain frontloading requirements under EMIR. Specifically, the authority may apply the frontloading rule only after it clearly defines which classes of derivatives will be subject to mandatory clearing and enters those technical standards into force.
HFT Drawing More Attention
In the wake of Michael Lewis’ latest book, Flash Boys, the realm of high-frequency trading (HFT) is coming under increased scrutiny. The book, which paints HFT in a poor light has sparked quite a bit of controversy and attention, and now the CFTC is jumping on the bandwagon.
On June, the Commission’s Technology Advisory Committee, which is chaired by Commissioner O’Malia himself, will meet to discuss Lewis’ claims that the U.S. stock market is “rigged” by HFT firms, which use technology to trade ahead of other market participants. The committee will also consider whether these claims apply to futures exchanges and SEFs.
The meeting will also focus on the CFTC’s market surveillance capabilities, which O’Malia deemed inadequate to identify disruptive and manipulative trading practices amongst the millions of order messages. According to O’Malia, the Commission must spend more money to improve current systems.
The CFTC is not the only government body taking a closer look at HFT. The Senate Committee on Agriculture, Nutrition and Forestry, chaired by Senator Debbie Stabenow (D-MI), recently held a hearing on HFT and automated trading in the derivatives markets. Drawing testimony from experts at the CFTC, CME and MIT, the hearing sought to identify what the Commission can do “to help ensure market integrity.”
