Central clearing might not be required of exchanges in the EU.
The OTC derivatives provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act are the prime target of corporate and bank lobbyists seeking to sabotage them, or at least water them down.
But last week it appeared that the rules might just founder on their own. A fundamental disagreement over whether exchange-traded derivatives need to be centrally cleared had US and EU officials scrambling to reach a compromise that would avoid leaving a giant loophole in global derivatives rules.
The heart of the matter is the US belief that all standardized derivatives should be centrally cleared, and the European belief that exchange trading is enough. After a heated exchange last week between US Treasury secretary Tim Geithner and EU officials (see related story here), the parties agreed to establish a working group to sort out the issue. The group is slated to meet June 20.
The European approach would do little to address the core issue of bilateral counterparty credit risk in the market for standardized products, although it might improve price transparency. However, non-cleared electronic trading systems—ranging from crude electronic bulletin boards to interdealer brokers’ trade matching systems—are already in widespread use for a range of derivatives and their fees, margin and collateral requirements vary widely.
If the US cannot convince the EU to force standardized derivatives through clearinghouses, treasurers may seek to take their hedging business overseas, and employ foreign-domiciled banks. They could then enjoy the best of both worlds – with narrower margins and better price transparency due to exchange trading, and lower clearing costs than in the US. This could result in significant savings over time.
But such a bifurcated regulatory situation could bring Mr. Geithner’s worry about a regulatory race to the bottom, which he also articulated last week to the significant dismay of other G20 regulators, a step closer. Whether that’s a bad thing or not depends on whether a domestic derivatives market conveys any advantage to end-users. As an OTC desk head at a German bank recently said, “It just means our taxpayers get screwed, not yours, next time things blow up.”