The centralised clearing model continues to evolve around the world. The push for change is currently being driven overwhelmingly by policymakers and new regulations. Moving forward, developments and innovations in various technologies are likely to create both threats and opportunities for clearing systems as well. Roger Storm, Head of Regulation, Risk and Committees at SIX, shared his insights at this year’s AFME (Association for Financial Markets in Europe) European Post-Trade Conference in London, whereby he outlined some of the changes and pressures facing the securities ecosystem.
Fragmentation and extraterritoriality in Europe
Even though a number of attendees at the AFME Conference were not entirely convinced that Brexit will actually transpire, CCPs (central counterparty clearing houses) cannot ignore the potential consequences that a disorderly UK departure from the EU may bring. Aside from the obvious disruption risk, Brexit has also forced European policymakers to revisit their attitudes towards granting third-country firms access to the EU, which means non-EU CCPs have now found themselves in the middle of this messy cross-fire owing to their systemic importance. Fortunately, both the UK and EU spotted this problem and have granted each other temporary recognition, in the case of no withdrawal agreement.
However, regulations in the EU continue to evolve. The now - almost final - revisions to the European Market Infrastructure Regulation (EMIR) – also referred to as the EMIR Review or EMIR 2.2 – not only provides some relief around existing clearing obligations, but it also strengthens the EU’s supervisory regime over CCPs in general. It will do this by establishing a multi-tiered supervisory approach towards EU and recognised third country CCPs.1 The amendments introduce a classification system for third country CCPs, dividing them into two camps, namely CCPs which are seen to be an “ordinary” risk to EU financial stability (Tier 1) versus those deemed to be substantially systemically important (Tier 2).2
Storm says the proposals are - in effect - extraterritorial, pointing out the new European CCP regulatory bodies will likely have a significant say over non-EU, tier 2 CCPs’ operating models. If such a CCP were to reject EU demands, it could lose its recognition and may even be forced to relocate. Given the global nature of financial markets, it is understandable that CCPs active in multiple jurisdictions will be of interest to a number of financial market regulators. An alternative – and the historic - regulatory approach has been facilitated through cooperation agreements, and deferral of supervision, but it appears the EU is now taking a new strategic direction towards monitoring and oversight of third country CCPs.
Leveraging new technologies for a more efficient market
While Brexit may force change onto the EU’s financial markets, the Capital Markets Union initiative (along with other select government projects) and emerging new technologies will also prompt major reforms within the industry. The ability to seamlessly obtain and move high-quality collateral and post it as margin and default fund contributions at CCPs (or to their counterparties in bilateral OTC derivatives trades) is still an area of concern for many market players. The EPTF (European Post-Trade Forum) report (following up on the earlier Giovannini report) in 2017 underlined many of the barriers that are still hampering the evolution of a truly harmonised single EU-market for financial instruments.
“Maybe some of the emerging technologies, such as tokenisation, will help remove these barriers as well”, says Storm. “Tokenisation, possibly combined with Distributed Ledger Technology (DLT), could allow a reset of some legacy rules, and thereby make it easier and more efficient to mobilise and pledge collateral across the EU,” he adds. Even in scenarios where new technologies could pave the way for true real-time processing, Storm is not concerned about the impact such breakthroughs will have on the current CCP landscape.
SIX x-clear operates a real-time system today, and wherever the underlying instruments (e.g. derivatives) have a time lag between the trade’s conclusion and the final legal settlement of the claims, the safety net provided by a CCP sitting in between a transaction will continue to be demanded of by the market and regulators. Storm adds there are also significant liquidity and financing costs attached to real-time gross settlement (RTGS), pointing out a number of ancillary business activities (securities lending and borrowing, collateral transformation for clearing members) often make use of these time gaps.
Unless the EU and UK find agreement on Brexit, allowing for the continued provision of cross-border financial services, the industry – be it investors, investment firms, trading venues, CCPs, Central Securities Depositories and custodians, will all have to implement meaningful changes to their business frameworks. The EU is forging ahead with its reform agenda, and supporting emerging new technologies for the benefit of the Union’s financial markets. The former deferral oversight regime, however, is likely to change, so third country firms will either have to dance to the EU’s tune or step out entirely.
1 Deloitte (May 2, 2019) What lies in store for third-country firm access to the EU in a post-Brexit world?
2 EY (November 2018) EMIR, changes on the horizon