Welcome to the second day of IDX. I hope you’ve enjoyed the event so far, and the wide range of discussions—covering Brexit, MiFID II, the ESA Review and the EMIR Review.
Over the course of the next 15 minutes, I’m going to provide a perspective on the issues and challenges we face, and how FIA seeks to help its members address them.
Very few industries have the pace of change and competitive environment of the cleared derivatives industry, but perhaps Formula 1 motor-racing, with its level of competition, new rulebook every year, and focus on technology is a good analogy. So whom better to think of for inspiration than Ferrari?
In his book, “Total Competition”, Ross Braun – the previous team principal of the Ferrari Formula 1 team – explained that when he manages a successful team, he views the challenges through three lenses:
- The political;
- The economic; and
- The technical.
I’ll use those three lenses as the structure for this presentation.
Let’s start by looking at our industry through the first lens: politics
Central clearing wasn’t a terribly political issue for many years. It was seen as a utility service – the industry plumbing that “just works”. Not very exciting. Not very dynamic. It’s just “there”. Then the financial crisis happened. Clearing proved very successful in managing the risks resulting from it. That in turn led to the G20 commitments of Pittsburgh of 2009. Central clearing became a cornerstone of financial reform legislation.
The political relevance of central clearing peaked again when last year, the UK went to the polling booth and delivered a shock result – the British public (or, at least, those who turned up to vote) expressed its desire for the UK government to pull the UK out of the European Union. The following day, the President of France and the President of the European Commission called for the central clearing of euro-denominated derivatives to be forcibly relocated to clearing houses located in the EU27.
Suddenly our industry is front page news – and not just in the specialist financial press, but in the mainstream media. Now clearing matters politically. Not just in financial services, but across the topic of Brexit as a whole.
So what is FIA doing in light of the unprecedented political attention now paid to our industry?
FIA staff, its board members and representatives from FIA’s member firms have been active in meeting not only the influencers, but also the decision makers at the highest levels at the European Council, European Commission, various National Competent authorities, central bankers, politicians and diplomats.
We also, of course, raise the profile of the industry’s concerns with decision makers here in London and in the US.
As Walt set out in his speech yesterday, FIA in its letter to the European Commission said that enhanced oversight is preferable to forced relocation as a means to address the financial stability and monetary policy concerns of the EU27.
So that’s politics. What about the second of Ross Braun’s lenses: economics?
Our markets enable end-users to manage their exposure to risk, be that risk relating to price, interest rates, inflation, fx, counterparty risk or otherwise. These are critical tools.
Clearing is not something abstract - the political decisions taken with respect to Brexit will have real world, economic, consequences. It is therefore critical that whilst Brexit is first and foremost a political process, the economics must not be forgotten or ignored.
The worst outcome for everyone is:
- Fragmented markets
- End-users cut off from deep, liquid, markets and their service providers
- Financial instability caused by cliff-edges or too short a time to implement the necessary changes.
Accordingly, FIA’s messaging to decision-makers on both sides of the English Channel relating to Brexit is simple – you should seek to:
- Minimise disruption: yes, that means transitional arrangements
- Avoid fragmentation: let the market decide where to centrally clear derivatives, in order to deliver maximum efficiencies
- Maintain global access without disruption:
- ensure that EU end users can meet their mandatory trading and clearing obligations by executing and clearing their derivatives transactions on UK market infrastructure and reporting the details of those trades to trade repositories located in the United Kingdom
- continue to enable service providers located in the UK to access their clients in the EU27, and vice versa – this is what the third-country passport provisions in MiFID II and MiFIR are designed for.
But Brexit is not the only economic challenge faced by our industry.
Markets regulation such as EMIR and Dodd-Frank each call for more central clearing of derivatives. However, economic pressures, whether that be:
- the leverage ratio’s failure to recognise the exposure reducing effect of margin;
- the intermediate holding company regime, that imposes additional capital costs in the US (and soon, in Europe);
- the low interest rate environment eroding part of clearing brokers’ traditional revenue streams; or
- the sheer cost of implementing the avalanche of regulation
All of those economic pressures put unprecedented strain on the economics of running a client clearing business. We have already seen several banks pull out of the business, either entirely or with respect to their OTC derivative client clearing franchise. This is a trend that is likely to continue, thereby further restricting access to central clearing of derivatives and potentially worsening the ability of clearing houses to successfully manage the process of dealing with the default of a major clearing member.
In order for central clearing to be successful, you need clearing brokers and you need them to be profitable.
Europe is taking the lead – the European Commission has recognised that if it is to successfully achieve its objective of promoting and ensuring the central clearing of standardised and liquid derivatives, it must become part of the solution. Through its Call for Evidence process and via other means, the European Commission and ESMA have identified the need:
- for the leverage ratio to be amended to provide an offset for client margin; and
- for EU regulation to become “smarter”, by removing duplication, filling gaps and addressing unintended consequences.
Finally, to the third lens: the “technical”
In our world, this really falls into two sub-categories:
- managing the implementation of ever-changing regulation; and
- addressing the threats and opportunities provided through Fintech.
At a personal level, what makes my day-job so interesting is that I have conversations on 5 to 15 different topics in any given day. There is so much regulatory change going on, that there is always something important to discuss with legislators, regulators and our members.
In Europe, our focus is in three key areas for 2017:
- MiFID II
- Clearing house recovery and resolution
- Analysing and providing input on other regulatory reviews
We’re delivering for our members in all of these areas.
What is FIA doing with respect to MiFID II? FIA is delivering for its members by being a one-stop shop to discuss the issues and implement them using industry standard templates.
Among our work:
- We are updating documentation, producing templates, liaising with market infrastructures, and working on best practices, due diligence questionnaires and FAQs
The second aspect of our technical lens is CCP Recovery and Resolution
My colleagues Jackie Mesa, Declan Ward and Corinna Schempp are very active in their work on this key topic. Having received plenty of feedback from members, our focus is now on advocacy with legislators and regulators around Europe.
Finally, managing and reviewing change. This is a wide area that encompasses Brexit, the EMIR Review and the ESA Review
I’ve spoken about Brexit already.
What about the EMIR Review? We are reviewing the proposals with our members. There is much to welcome – many of the changes being proposed were specifically put forward by FIA in its response to the European Commission’s consultation on the EMIR Review.
As ever, however, there are specific proposals that require further consideration and clarification. Two key issues relate to:
- Firstly: The new “FRAND” principle. This requires clearing brokers to offer their services to clients on “Fair, Reasonable And Non-Discriminatory” terms to their clients. EMIR I and MiFID II already require clearing brokers to provide their services on “commercially reasonable” terms, so what is it specifically that the words “non-discriminatory” are seeking to add? Both the detailed proposals and their potential negative consequences require a detailed study, as getting this wrong could lead to less central clearing and less porting of positions upon a clearing member default, not more.
- Secondly: the bankruptcy remoteness proposals. Under these proposals, client collateral held by a clearing member or a CCP could be excluded from the bankruptcy estate of the clearing member. Again, the specifics of these proposals will require detailed analysis.
And the ESA Review? In this recent European Commission review, they looked at the future role of the three European Supervisory Agencies. Our next speaker, Stephen Maijoor, is chairman of one of them – ESMA. We look forward to hearing his views shortly.
One of the key trends that we have seen post-referendum is a suggestion that more powers be centralised within ESMA itself, rather than at the national competent authority level. It is also being considered whether ESMA should be given enhanced oversight of third country clearing houses – this is something that FIA would favour over the forced relocation of derivatives to the European Union.
FIA filed its response to the ESA consultation last month. Among various recommendations, we proposed improvements to the process by which ESMA drafts and phases-in legislation, and recommended creating a European version of the CFTC’s “no-action” letter regime. We also called for further analysis of ESMA’s proposal to centrally regulate all CCPs and CSDs in the UK and issued a call for caution regarding direct supervision of third country firms that are recognised by the EU.
And it’s not just about regulatory change. Our world is becoming ever more digital. As regards Fintech, we are working through our approach and welcome your feedback. For now, regulators around the globe are taking a “do no harm” approach, but as the number of industry consultations shows, this is constantly under review. Fintech, and its subset “Regtech”, will inevitably be a key coverage area for us going forward.
So, in conclusion, there’s a heck of a lot on! FIA’s members are facing an unprecedented amount, and pace, of change. As the industry’s representative and partner, FIA is here to help its members manage through the transition. We do that, as ever, by focussing on what trade associations do best – on your behalf, we:
- Give our members the opportunity to successfully network and learn from one another through our conference of events, of which this event, IDX – our premiere European conference – comprises a critical part.
Thank you for coming to IDX this year and playing a part in its success.