The European Securities and Markets Authority issued a discussion paper seeking views on the time horizon for liquidation and other issues related to the setting of margin for customer accounts by European clearinghouses (CCPs) and brokers. In Europe, clearinghouses are currently required to collect margin from clearing members for their customers on a net basis, assuming a two-day liquidation horizon for financial instruments other than over-the-counter derivatives. The same standard applies to proprietary accounts of clearing members too. However, unlike in the United States, proprietary accounts do not include affiliated entities. Affiliates are considered customers. In the United States, by comparison, clearinghouses collect margin from clearing members for their customers on a gross basis assuming a one-day liquidation horizon. According to ESMA, when it set a two-day liquidation period it presumed “that at a minimum [a] CCP would need two days to either port or liquidate client accounts for instruments other than OTC derivatives, which are generally more liquid and easier to be liquidated than OTC derivatives.” ESMA seeks views on the sufficiency of one-day gross versus two-day net margin, whether affiliates should continue to be considered customers and whether, if it adopts the shorter time threshold, changes should be made to requirements around intraday margins, among other matters. ESMA is not considering changing the time horizon for setting margin for non-customer accounts, however, because “[a] reduction of the liquidation period in the house account would mean allowing a one-day net margin level, which in ESMA’s view would not allow the CCPs to have a sufficient level of margins to manage a default, thus impacting the resources of the non-defaulting clearing members and the stability of the CCP.” Comments will be accepted through September 30, 2015. (Click here for additional information on ESMA’s consultation in the article “ESMA Publishes Discussion Paper on EMIR Standards Relating to CCP Client Accounts” in the August 28, 2015 edition of Corporate & Financial Weekly Digest by Katten Muchin Rosenman LLP.)
My View: Although in evaluating minimum margin-collection requirements of clearinghouses and brokers ESMA makes clear that it is not attempting to prejudice deliberations of the European Commission “on the equivalence of the legal and supervisory regimes for CCPs in the USA,” in fact, ESMA is showing its cards. According to ESMA, “a preliminary comparison … has shown that the margins held at the CCP according to the gross margining method in combination with a one-day liquidation period are (typically, but not always) higher than margin requirements calculated according to the net margining method in combination with a two-day liquidation.” Moreover, with gross margining, clearing members post more client assets with a clearinghouse than hold it themselves; this should make porting of client positions easier in case of a clearing member default. In light of this, the European Commission should quickly conclude that oversight by the Commodity Futures Trading Commission over US clearinghouses is equivalent (if not identical) to EC oversight over European CCPs in order to avoid European banks being subject to putative capital requirements for exposure to US clearinghouses. Enough dithering! (Click here for background on the relevant issues in the article “CFTC Chairman Argues for Equivalent Treatment for US CCPs by the European Commission; EC and CFTC Commit to Continue Talking—That’s All for Now” in the May 10, 2015 edition of Bridging the Week.)
Helpful to Getting the Business Done: In considering the arguments in the debate regarding sufficient liquidation horizons at the clearinghouse level, exchange-traded and/or centrally-cleared derivatives brokers should not lose sight of the fact that, following a client default, it might take multiple days (far more than one or two), if not weeks, to liquidate a complex client portfolio involving illiquid products, particularly those including some options and swaps. ETD brokers should regularly evaluate the liquidity of their clients' positions and adjust margin requirements or take other precautions accordingly, or at least ensure they are adequately compensated for the risk they incur in holding illiquid products for clients.