September 11, 2014 / 11:41 AM / 5 years ago

REFILE-EU's OTC derivatives proposals threaten Asian regulatory clash

(Refiled to give full second name of speaker in final paragraph)

By Michelle Price

HONG KONG, Sept 10 (Reuters) - Tensions are growing between regional regulators over a proposal on collateral requirements that would make it more costly for Asian companies to trade with European banks in off-exchange derivatives — the often complex financial products used to hedge against price swings in underlying assets ranging from interest rates to commodities.

Banks and investors have already criticised Europe for diverging from agreed international standards and have warned that the European proposal could increase the cost of trading over-the-counter derivatives, such as interest rate swaps, in Asia by hundreds of billions of dollars, threatening systemic stability and potentially forcing EU banks out of the Asian OTC derivatives markets.

“This is a huge concern for EU banks,” said John Ho, Co-Head, Financial Markets, Wholesale Banking Legal, at Standard Chartered in Singapore. “If this goes through, EU banks operating in Asia will be put at a competitive disadvantage.”

The Australian Securities and Investment Commission, Japan’s Financial Services Authority, the Monetary Authority of Singapore, and the Hong Kong Monetary Authority, as well as a number of Asian central banks, have raised concerns behind the scenes and are in discussions with EU regulators on the matter, according to several individuals with knowledge of the discussions.

One official at Japan’s FSA, who declined to be named due to the sensitivity of the issue, said international harmonisation of the new rules was “critical” and that the FSA was liaising with foreign regulators on the matter.

A spokeswoman for the European Commission said it was “well aware” of the issues raised by banks and foreign watchdogs and added that the Commission was working with Europe’s banking and securities regulators on “appropriate responses”.

The EU proposal comes amid growing international strain over the implementation of new rules drawn up by the G20 nations governing off-exchange derivatives markets in the wake of the financial crisis, which has sparked a number of diplomatic skirmishes.

“The U.S. and Europe have a very outward-looking approach and put a lot of hurdles into the Asian market,” said Michael Steinbeck-Reeves of Catalyst Consulting in Japan, who is working with banks on the new rules. “We have to hope the regulators don’t end up in a battle over this.”


Regulators internationally are overhauling the global OTC derivatives market after it emerged that companies like failed U.S. insurer AIG amassed huge amounts of unseen risk exposure through trading privately-negotiated derivatives such as credit default swaps.

New rules aim to make trading OTC derivatives safer by pushing as many as possible through clearing houses, which sit in-between a trade to guarantee payment if either counterparty defaults.

However, around $127 trillion worth of the global $600 trillion OTC derivatives market are too complex to be cleared, according to research published by the International Swaps and Derivatives Association in 2012.

New international guidelines subsequently agreed by global regulatory banking and securities bodies the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) in September 2013 aim to make trading these non-clearable OTC derivatives safer by requiring banks to take collateral - such as bonds or equities - from a counterparty as protection should either party default.

The process, known as “bilateral margining”, dramatically increases the cost of trading derivatives by tying up liquid assets. The ISDA estimated that in the worst-case scenario the implementation of bilateral margining globally could suck up $10.2 trillion.

Regulators in the United States, Europe and Asia are in the process of turning the BCBS-IOSCO guidelines into national law, with Europe publishing its draft rules in April, followed by Japan in July and the U.S. earlier this month.

But Europe’s draft rules have caused consternation among EU banks and Asian regulators by effectively requiring EU banks to treat counterparties based outside Europe as riskier than EU trading partners, even though many such entities have higher credit-ratings than their EU peers.

“The EU proposal has departed from the BCBS IOSCO guidelines in a number of ways and has created a two-tier playing field for EU and non-EU entities,” said Keith Noyes, regional director, Asia Pacific at ISDA.

Specifically, the rules exempt small-scale European ‘end users’ of OTC derivatives, such as a food manufacturer hedging exposure to sugar prices, from posting margin, but does not exempt the same types of firms based outside Europe.

Similarly, the draft rules exempt European central banks, the U.S. Federal Reserve and the Bank of Japan from posting collateral when trading with EU banks, but all other central banks will be required to do so.


The proposal is especially worrying for Asian regulators because European banks are major providers of liquidity to the Asian OTC derivatives market, said bankers and derivatives experts, and many Asian companies do not have the liquid assets or operational resources necessary to meet the EU’s demands. “In the short term, Asia would be impacted without that liquidity. But in the long term, EU banks will find it hard to compete in these markets if they must demand margin when their competitors do not have to,” said Noyes.

ICI Global, the international investor group, has warned that the EU draft rules “could threaten systemic stability”.

The Hong Kong Monetary Authority, Hong Kong’s de facto central bank, said it “noted” the EU’s divergence from international standards, and added it would “continue the dialogue with the EU authorities on various cross-border issues, including the application of the proposed bilateral margin rules, in order to maximise global consistency.”

Singapore’s MAS said it would “monitor developments” on cross-border rules “closely.”

The European Commission is expected to provide feedback on the draft rules later this year.

One person familiar with the Commission’s thinking said the regulator was sympathetic to industry concerns but the issue was not currently a priority and Europe was unlikely to back down on all the contentious aspects of the draft.

However, critics said the EU proposal is a further example of growing Western extra-territoriality, whereby U.S. and European regulators look to impose their post-financial crisis rules on foreign jurisdictions, including each other’s.

The strategy, which aims to ensure that U.S. and European banks can’t escape tough domestic rules by moving to more relaxed foreign jurisdictions, has led to turf-wars between the U.S and Europe, and stirred discontent among Asian regulators who feel their sovereignty has been trampled upon.

The United States and Europe, for example, have reached a deadlock over whether they will approve each other’s clearing houses, Reuters reported earlier this month, while European and Asian regulators locked horns over a similar issue last year. “Asia is constantly one step behind, trying to go with the spirit of the foreign rules,” said Steinbeck-Reeves. “The US and Europe aren’t always sympathetic to this.” (Additional reporting by Huw Jones in London; Editing by Greg Mahlich)

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