Abstract
The global crisis triggered a vast programme of financial markets reform, including a new regime for over-the-counter (OTC) derivatives which requires hitherto private contracts to be cleared through central counterparties (CCPs). This article argues that the interaction between underlying law and this new regulation needs to be addressed in order to advance the objectives of the reforms. The starting point for the argument is the two techniques that underpin CCPs: limited access and posting assets, or margin. Having established that access via intermediated or ‘client’ clearing will become increasingly important with mandatory clearing, the article explores the impact of client clearing on the legal rules governing the margin posted by users of a CCP. The detail of the interaction between European regulations on CCP clearing and the UK rules on client assets is considered as an example. The dilemma identified arises because regulation, designed to improve financial stability by mandating clearing, may potentially undermine certain ways in which CCPs promote that outcome. The article concludes that the interaction between underlying law and new regulation needs to be accounted for and addressed at EU level, in order to safeguard the functions that attracted regulators to clearing in the first place.
Highlights
Central counterparties (CCPs) are post-trade, pre-settlement market infrastructure
Having established that access via intermediated or ‘client’ clearing will become increasingly important with mandatory clearing, the article explores the impact of client clearing on the legal rules governing the margin posted by users of a central counterparties (CCPs)
European Market Infrastructure Regulation (EMIR) provides that classes of contracts may become subject to the clearing obligation either by a ‘top down’ approach initiated by European Securities and Markets Authority (ESMA) acting ‘on its own initiative’, or by a ‘bottom up’ approach, based on classes of contracts already cleared by CCPs
Summary
Central counterparties (CCPs) are post-trade, pre-settlement market infrastructure. They clear contracts of many kinds by becoming buyer to every seller and seller to every buyer. A combination of legal techniques including novation, netting and asset-backing enables CCPs to assume market participants’ counterparty credit risk and act as a ‘shock absorber’ by mutualising losses in times of market failure For this reason, CCPs can be thought of as ‘legal devices’, where the underlying legal techniques both explain and constrain how clearing services work.. It offers a way of exploring the interaction between different legal techniques, and how those techniques may be complicated by exogenous factors like new financial markets regulation Building on this insight, this article offers an analysis of the interaction between two of a CCP’s key risk management tools, being selective membership and collecting margin, and the new regulatory regime for over-the-counter (OTC) derivatives.. This means that one of the effects of the new regulatory regime for OTC derivatives will be to increase the importance of the legal structures behind ‘client clearing’ arrangements Level in order to safeguard the functions that attracted regulators to clearing in the first place
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