European Scrutiny Committee Contents

6   Financial services




+ ADDs 1-2

COM(10) 484




Draft Regulation on OTC derivatives, central counterparties and trade repositories

ECB Opinion on a draft Regulation on OTC derivatives, central counterparties and trade repositories (CON/2011/1)

Legal base(a) Article 114 TFEU; co-decision; QMV

(b) —

Document originated(b) 13 January 2011
Deposited in Parliament(b) 19 January 2011
DepartmentHM Treasury
Basis of consideration(a) Minister's letter of 12 February 2011

(b) EM of 31 January 2011

Previous Committee Report(a) HC 428-iv (2010-11), chapter 4 (20 October 2010)

(b) None

To be discussed in Council15 March 2011
Committee's assessmentPolitically important
Committee's decisionNot cleared; further information requested


6.1  In September 2009 the G20 at Pittsburgh agreed:

"To this end, all standardized OTC [over-the-counter] derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest. OTC derivative contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements."[29]

6.2  In September 2010 the Commission published this draft Regulation, document (a), on OTC derivatives, central counterparties (CCPs) and trade repositories. The proposal seeks to address deficiencies in the derivatives markets as evidenced by the financial crisis, as well as establish harmonised EU standards for clearing houses.

6.3  When we considered the proposal, in October 2010, we heard that:

  • the Government believed the draft Regulation justified under the principle of subsidiarity, because of the need to have consistent application of the clearing obligation throughout the EU;
  • it would be keen, however, to ensure that national authorities would have a central role in supervising both CCPs and trade repositories, given that the draft Regulation proposed national supervision of CCPs but supervision of trade repositories by the relevant European Supervisory Authority;
  • it fully supported implementation of the G20 commitment to increase the safety of the OTC derivatives market;
  • the draft Regulation was a critical element of the package of regulatory reforms being implemented in response to the financial crisis, addressing some of the fundamental weaknesses revealed by it;
  • transparency in the OTC derivatives market would be transformed by the reporting of transactions to trade repositories and the management of counterparty risk would see a step change enhancement through obligatory central clearing for appropriate derivative products;
  • the Government was aware of the potential implications of concentrating systemic risk within CCPs and the cost of requiring market participants to hold more collateral against derivative positions to comply with CCPs risk management requirements;
  • overall it believed, therefore, that these aims should be achieved in a way that would not discriminate against UK market participants and infrastructures, would ensure the regulatory burden imposed was proportionate to the benefit in terms of systemic risk reduction and would support introduction of robust prudential standards for CCPs — it was important that reforms would be implemented consistently across G20 partners to prevent regulatory arbitrage;
  • the Government broadly supported the Commission's proposal, but noted that the impact on market participants and the resulting reduction in systemic risk would in large part be determined by the detailed technical rules the draft Regulation would require the European Securities and Markets Authority and the European Banking Authority to develop for adoption by the Commission;
  • given the inherently prudential nature of much of the proposal, the Government believed there were good arguments for a greater involvement of the European Banking Authority in developing and implementing these rules than the draft Regulation currently proposed;
  • the Government supported assigning the European Supervisory Authorities responsibility for determining which products should be subject to the clearing obligation, a key part of this proposal, and would be concerned to ensure that the European Supervisory Authority had the flexibility and expertise to take these decisions in an appropriate and proportionate way;
  • the Government supported the principle in the proposal that no CCP should be forced to clear a product it was not comfortable risk managing;
  • it supported the proportionate approach suggested by the Commission for corporate (non-financial) market participants, but noted that more work would be required by the European Supervisory Authorities to ensure the detailed implementation of the proposed thresholds would be effective in reducing systemic risk, while not imposing unnecessary uncertainty and burden on corporate users of OTC derivatives;
  • it believed there might be a case for similar flexibility in applying the clearing obligation to financial firms which did not present a systemic risk;
  • it supported the Commission's proposal to give national regulators the lead role in supervising and authorising CCPs, given the potential fiscal risk they represented;
  • it believed that national authorities should be responsible for the authorisation and ongoing supervision of trade repositories;
  • it broadly agreed with the conclusion of the Commission's impact assessment, albeit that it was largely qualitative in nature, given the opacity of the OTC derivative markets, that the costs were likely to be outweighed by the benefits of market stability brought about by these proposals;
  • the exact costs of the draft Regulation would depend on the scope of products that would ultimately be submitted to CCP clearing; and
  • the Government had consulted widely with CCPs, clearing banks and buy-side market participants and their trade associations as this draft legislation was being developed.

6.4  We noted that, although the Government was generally supportive of the draft Regulation, there were matters which it wished to see addressed during negotiation of the proposal. So we said that before considering the document further we wanted to hear about progress on these matters, including the potential subsidiarity point mentioned to us. We asked also to hear about the views of those the Government had been consulting about the draft Regulation. Meanwhile the document remained under scrutiny.[30]

The new document

6.5  The draft Regulation contains provisions affecting the operation of payment systems and the conduct of policies relating to the stability of the financial system, both of which are part of the competence of the European System of Central Banks. So on the basis of Articles 127 (4) and 282 (5) TFEU the European Central Bank (ECB) has delivered this Opinion, document (b) on the proposal. In the Opinion the ECB supports the objective of the proposed Regulation. However, it recommends a total of 46 amendments to the draft.

6.6  Its main objection is that the ECB and national central banks should have greater involvement in drafting technical standards, given the general oversight competence over clearing and payment systems deriving from the provisions in the statute of the European System of Central Banks and the ECB. In the view of the ECB there should be close coordination between the European Securities and Markets Authority and the European System of Central Banks in developing these standards. The ECB also believes that the central banks should be involved in the supervisory colleges of EU CCPs and in the recognition process whereby third country CCPs are allowed to operate in the EU. The ECB also:

  • stresses that further consideration should be given as to whether CCPs should be classified as credit institutions with limited purpose banking licences;
  • notes that central bank facilities are the most effective tool for market infrastructures in view of their liquidity and risk management needs; and
  • notes that the Regulation should not present commercial bank money as an equally safe and preferable option as central bank money.

The Government's view of the new document

6.7  In his Explanatory Memorandum the Financial Secretary to the Treasury (Mr Mark Hoban) says that the ECB Opinion requires no action and therefore does not have any direct policy implications for the UK. However, given that the Council and the European Parliament may consider these amendments, he sets out the Government's views on elements of the Opinion, saying that:

  • the Government in general supports the Opinion presented by the ECB, especially the affirmation of the G20 commitment to increase the safety of the OTC derivatives market;
  • the ECB is supportive of the regulatory proposals which the Government believes are critical elements of the reforms being implemented in response to the financial crisis;
  • the Government believes that transparency in the OTC derivatives market will be enhanced by the reporting of transactions to trade repositories and the management of counterparty risk will see a step change through the requirement of central clearing for appropriate derivative products;
  • it agrees with the ECB that central banks need to play a strong role in shaping the necessary technical standards and with the need for close cooperation with the relevant European Supervisory Agency — the European Securities and Markets Authority;
  • it believes, in relation to CCPs' management of liquidity risk, that CCPs should not rely on the provision of central bank liquidity, but should instead have robust controls to mitigate liquidity risk themselves, through a combination of cash, highly liquid collateral and other prearranged and reliable funding arrangements;
  • this includes, for example, committed facilities with commercial banks or members that allow CCPs to use their non-cash assets to meet funding needs;
  • this is also the approach foreseen by the international standards being developed by CPSS-IOSCO;[31] and
  • the Government does not believe that CCPs should be required to operate under a banking licence — as they do not perform the same functions as banks, it would not be appropriate to subject them to the same licensing regime, instead they should be subject to the rules and guidelines set out in the Regulation, once agreed.

The Minister's letter

6.8  The Minister writes to us in response to our comments in October 2010 about the draft Regulation, document (a). On negotiations he tells us that:

  • on the potential subsidiarity point regarding supervision of CCPs and trade repositories, there remains an outstanding concern on the oversight arrangement for CCPs and trade repositories;
  • the Government continues to oppose the current compromise text, which requires a joint positive opinion by the college of supervisors and central banks before a CCP can be authorised by the home competent authority — given the fiscal implications of a failure of a CCP, the home competent authority needs to be able to take authorisation decisions without explicit consent from the college;
  • on trade repositories, the Government continues to argue that home state authorisation and supervision powers should be maintained;
  • it hopes to find a balance between preserving these powers and the need for EU and international authorities to access relevant data on a timely basis;
  • working groups have also discussed CCPs' management of liquidity risk — the Government has maintained the view that it is not advisable to legislate for CCP access to central bank liquidity, given the potential for moral hazard and infringements on central bank independence;
  • the Government agrees with the current Presidency text that CCPs should be able to source liquidity from other sources, including commercial banks;
  • on the scope of the legislation there is strong opposition from some Member States to extending the scope of the proposed Regulation to all derivatives;
  • the Government believes, however, that restricting the scope to OTC derivatives only risks creating a loophole — firms could simply trade through trading venues to avoid the clearing obligation, which would run counter to the G20 objective of reducing counterparty credit risk; and
  • it supports, therefore, the current Presidency text, which includes all derivative products.

6.9  Turning to the views of those whom the Government has been consulting, the Minister says that:

  • a concern expressed by the buy-side firms is the obligation for long-term investors, in particular pension funds, to centrally clear and post a cash margin at the CCP — the current Presidency text does not exempt these funds from any obligations;
  • the Government is working with other Member States and the industry to find a solution to this problem, which could bring significant cost to these funds;
  • existing CCPs are also concerned about the college structure which is advocated in the proposed legislation;
  • the current compromise text allows for a multitude of overseers to participate in the college, including supervisors of clearing members, regulators of linked CCPs and central banks of those currencies cleared by that CCP; and
  • there are ongoing discussions on how to address these concerns —the Government agrees that the college arrangements should be simplified.

6.10  The Minister also tells us the ECOFIN Council is due to adopt a general approach on this draft Regulation on 15 March 2011.


6.11  We are grateful to the Minister for the information he gives us about developments on the draft Regulation, document (a), and we note his comment about the apparent intention to secure a general agreement on the proposal at the ECOFIN Council on 15 March 2011. But it seems to us that the lack of certainty about securing satisfactory progress on oversight arrangements for CCPs and trade repositories, on the problem of an obligation on long-term investors to centrally clear and post a cash margin, on simplification of college arrangements and, possibly, on the coverage of all derivative products means that agreement on a general approach is premature. Additionally we do not know whether a greater role for the European Banking Authority, which the Government told us was desirable, has been secured. So we do not think it appropriate yet to clear this document from scrutiny. Rather we would like to have a further account of negotiating progress in time for us to consider before the March 2011 ECOFIN Council.

6.12  As for the European Central Bank's Opinion, document (b), on the draft Regulation, given that the Council and the European Parliament will, as the Minister says, be considering the European Central Bank's views during development of the Regulation we should like to hear about that as part of the further report we are requesting here.

6.13  Meanwhile both documents remain under scrutiny.

29   See No. 70 of the Progress Report for more information on this commitment: Back

30   See headnote. Back

31   For CPSS (the Committee on Payment and Settlement Systems) see and for IOSCO (the International Organisation of Securities Commissions) see  Back

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