The European Securities and Markets Authority (ESMA) has today published its comprehensive final report regarding the implementation of the CPSS-IOSCO principles for financial market infrastructures in respect of central counterparties.
Following hot on the heels of the United States’ implementation of the requirement for all institutional FX trades to be processed via a central counterparty as part of the Dodd-Frank Act last year, the European Union took less than a year to emulate the methodology which will allow regulators to ensure full transparency on all OTC FX trades, with many European firms having gained regulatory approval to act as central counterparties recently.
EMSA considers that the difference between the operative language used in the EMIR framework and the operative language used in the principles for financial market infrastructure (PFMIs) were to prevent the EU from being graded as having consistently implemented the PFMIs in respect of central counterparties (CCPs) then there might be serious consequences for CCPs established in the EU (EU CCPs).
Indeed, Basel III requires that where an external assessment has identified that the regulatory requirements to which a CCP is subject have not consistently implemented the PFMIs in respect of CCPs, and the authorities in that jurisdiction have not since publicly addressed the issues identified, then banks might have to hold additional capital against their exposures to such CCPs.
This is not an issue for banks established in the EU because under Regulation (EU) No 575/2013 of the European Parliament and of the Council of June 26 2013 on prudential requirements for credit institutions and investment firms (“CRR”) the capital required to be held by a bank against its exposures to CCPs is driven by whether or not the CCP is authorised or recognised under EMIR.
However, if banks established in third-country jurisdictions have to hold additional capital against their exposures to EU CCPs because of differences between the operative language used in the EMIR framework and the operative language used in the PFMIs, then EU CCPs could be put at a competitive disadvantage to their international peers despite in practice being held to regulatory requirements which consistently implement the PFMIs.
Furthermore, ESMA considers that in some third country jurisdictions the framework under which an EU CCP can qualify to offer its services to clearing members and trading venues established in that third country relies on the EU CCP being subject to regulatory requirements which are consistent with the PFMIs. In this circumstance, according to the EU 2 Basel Committee on Banking Supervision, capital requirements for bank exposures to central counterparties could result in a competitive disadvantage if they were not able to obtain permission to operate in various third-countries because of differences between the operative language used in the EMIR framework and the operative language used in the PFMIs despite in practice being held to regulatory requirements which consistently implement the PFMIs.
If differences between the operative language used in the EMIR framework and the operative language used in the PFMIs were to prevent the EU from being graded as having consistently implemented the PFMIs in respect of CCPs then there might be serious consequences for EU CCPs.
In particular the Basel III rulings require that where an external assessment has identified that the regulatory requirements to which a CCP is subject have not consistently implemented the PFMIs in respect of CCPs, and the authorities in that jurisdiction have not since publicly addressed the issues identified, then banks might have to hold additional capital against their exposures to such CCPs.
Worthy of note to industry participants is the cost implication of not instigating these procedures, which manifests itself insofar as instead of applying a risk weight to their default fund contributions determined according to a risk sensitive formula, banks would be required to apply a risk weight of 1250% to their default fund contributions. Furthermore the risk weight applied to trade exposures to the CCP would double from 2% to 4%.
The complete document from ESMA can be viewed by clicking here.