LONDON Feb 26 New European Union rules designed
to bring stability and clarity to opaque derivatives markets are
sowing confusion among metals brokers, raising more questions
than answers for clients and throwing the fate of smaller firms
The bloc's European Market Infrastructure Regulation (EMIR)
is a package of reforms drawn up in response to the global
financial crisis, in which less regulated market conditions
allowed contagion to spread quickly.
"EMIR is a rule book without totally defined rules," said
Malcolm Freeman, chief executive of brokerage Kingdom Futures
and a former trader with London Metal Exchange (LME)
ring-dealing member INTL FCStone.
"Is it going to protect anybody? No. Will it stop rogue
traders? No. So what's it for?"
The reforms state all derivatives transactions must be
reported to a trade repository, introduce mandatory clearing for
certain over-the-counter (OTC) derivatives and impose higher
margin requirements on OTC derivatives that are not centrally
They apply to all European Union firms that buy or sell any
form of derivative, including those on interest rates, foreign
exchange, equities, credit risk and commodities, and apply
indirectly to non-EU firms trading with European companies.
EMIR was adopted in 2012 but is being phased in gradually,
with many of the most onerous rules taking effect this year.
Brokers on the 137-year-old LME feel squeezed by the new
rules because they come at a time of ever-shrinking margins,
with some commissions down to around 15 to 25 cents a tonne.
They also worry the exchange will raise its trading fees
from next year, as Hong Kong Exchanges and Clearing,
which also runs the Hong Kong bourse, struggles to justify the
$2.2 billion it paid for the LME in 2012.
To cope with the burden of EMIR compliance, some brokerages
are absorbing costs, others are passing them on to clients by
charging a flat fee, while at least one is levying fees based on
the volume of business its clients transact.
QUAGMIRE OF UNCERTAINTIES
As a reflection of the uncertainty surrounding EMIR, the
EU's markets watchdog wrote to the European Commission earlier
this month to seek clarification on the definition of a
derivative, which varies across Europe.
The European Securities and Markets Authority (ESMA) sent
the letter just two days after the requirement to report
derivatives trades came into force on Feb. 12.
Brokers are just as baffled as to how European regulators
will use the reams of data to which they now have access to stop
risky derivatives positions building up.
Michael Overlander, chief executive of leading LME brokerage
Sucden Financial, said his firm had reported almost a million
transactions in the week after the EU reporting requirements
took effect, a time when the markets were quiet.
"Who knows what it's going to be like if the markets start
to heat up," Overlander said. "It's an absolute quagmire of
A senior executive at another large LME brokerage said the
firm had taken on new staff to ensure it complies with EMIR,
while another said EMIR was distracting entire departments.
"We are hand-holding customers through the new regulations,"
the executive said. "People are calling multiple times to ask
about what they have to report and which forms they need to fill
The United States introduced mandatory derivatives reporting
in 2012, but last year a U.S. regulator said the data did not
pick up the "London Whale" derivatives trades that cost JPMorgan
Chase & Co over $6 billion in 2012.
The LME - the world's largest marketplace for industrial
metals - said in written comments that while EMIR compliance
would inevitably increase costs for members and their clients,
the impact on liquidity was difficult to predict.
In September, it is set to launch its own clearing house,
LME Clear, which members will be obliged to use.
MORE PAIN AHEAD
One possible outcome of the heightened regulatory scrutiny
is that the pool of brokerages will shrink, meaning clients will
have less choice and pay higher commissions.
"The problem is that EMIR is bound to favour the bigger
institutions over the smaller ones, because economies of scale
will make them better able to absorb costs," said Steven
Spencer, managing director of LME brokerage Traderight.
But the biggest hurdles for LME brokers may be yet to come.
At some stage in the second half of this year, firms will
have to clear centrally a range of OTC derivatives, and broker
and client accounts must be segregated at the clearing house.
European regulators are yet to specify exactly when these
rules will take effect, and ESMA is yet to decide which
derivatives must be centrally cleared, adding to the confusion.
Brokers say this particular subset of rules will hurt
liquidity and drive up costs for the hundreds of firms that use
the LME to hedge their exposure to industrial metals prices.
Whereas traditionally brokerages have extended credit to
clients at little or no cost, the account segregation rules will
restrict them from doing so, meaning they will be likely to
charge more for providing the same service.
"It's almost like EMIR wants to get rid of credit, make the
market cash-settled," Kingdom Futures' Freeman said. "It will
make being a traditional broker-dealer very difficult."