6 Financial services
| (a)
(31958)
13917/10
+ ADDs 1-2
COM(10) 484
(b)
(32446)
5363/11
—
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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)
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| Legal base | (a) Article 114 TFEU; co-decision; QMV
(b) —
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| Document originated | (b) 13 January 2011
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| Deposited in Parliament | (b) 19 January 2011
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| Department | HM Treasury
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| Basis of consideration | (a) Minister's letter of 12 February 2011
(b) EM of 31 January 2011
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| Previous Committee Report | (a) HC 428-iv (2010-11), chapter 4 (20 October 2010)
(b) None
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| To be discussed in Council | 15 March 2011
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| Committee's assessment | Politically important
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| Committee's decision | Not cleared; further information requested
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Background
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.
Conclusion
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: http://www.g20.org/Documents2010/07/July_2010_G20_Progress_Grid.pdf. Back
30
See headnote. Back
31
For CPSS (the Committee on Payment and Settlement Systems) see
http://www.bis.org/cpss/index.htm and for IOSCO (the International
Organisation of Securities Commissions) see http://www.iosco.org/.
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