Saturday, February 13, 2010

Europe Regulators Give Info On Clearing Links

Posted in the Wall Street Journal by Adam Bradbery:

The U.K., Swiss and Dutch financial regulators wrote to several European clearinghouses Friday to tell them they believe the risks created by interoperable links between them will be manageable but will require increased use of collateral, according to a person familiar with the matter.

The letter, which follows requests for regulatory clearance of links between clearinghouses in those countries, suggests that delays in achieving interoperability between European clearinghouses in a bid to reduce trading costs will be overcome, albeit in time.

Clearinghouses stand between counterparties to a trade, guaranteeing trades in the event one party goes into default.

The U.K.'s Financial Services Authority, the Netherlands' Autoriteit Financiele Markten, and the Swiss Financial Market Supervisory Authority, or Finma, wrote the letter, in which they made it clear they don't reject the idea of interoperability and that the risks involved can be managed, the person said.

The regulators also said the creation of links between clearinghouses will increase credit exposures between those companies, which will need to be managed by holding adequate collateral to compensate one company if another they are linked to goes bust. This means there will be an increase in the collateral used by companies.

The supervisors also said they won't determine which models clearinghouses must use to calculate collateral levels but they will need to show they adequately cover the risks they face. They also said that clearinghouses may need to take into account other risks to manage, including operational, legal and technical risks.

The letter from the regulators was triggered by an application made by European Multilateral Clearing Facility, a Dutch clearing house, to the Dutch regulator in the last week of December for approval of a link with LCH.Clearnet (LCHC.YY), the European clearing house company, which would allow EMCF to handle U.K. and Swiss equity trades.

LCH.Clearnet, which clears trades in the U.K., already has a link with SIX x-clear Ltd., the Swiss clearing company, which has operated since 2003.

The Dutch regulator put the approval process on hold until it had conferred with the FSA and Finma on how to manage the risk that the collapse of one clearing house could knock on to other clearing houses due to these links.

EMCF said in a statement it welcomed the guidance from regulators, which it is now studying ahead of making further comment next week.

"EMCF is happy that there is now clarity about the direction regulators are going with regard to interoperability," the company said in the statement.

LCH.Clearnet and SIX x-clear declined to comment on the matter.

The European Commission, the European Union's executive body, forced national exchanges and trade processing companies in 2006 to agree to creating links between each other as part of a code of conduct designed to reduce trading costs. The agreements would allow an investor in one country to more cheaply process stock trades executed on overseas markets by using one clearing or settlements house.

Currently, the cost of cross-border trading in the EU is higher than domestic trading and much more costly than clearing in the U.S. because trades in each country are channeled through domestic clearing and settlement systems, which means market users have to pay agent banks to get access to each of them.

More than 80 requests for links were lodged by trade-processing companies. However, the overwhelming majority never progressed because some companies wanted to protect their captive trade processing businesses or because national regulators failed to give them the green light due to concerns the links could spread problems across borders if one company went bust.

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