Europe looking 'dysfunctional and extreme' over Esma equivalency procedure

Chaotic implementation of the equivalency process by Europe's financial regulator combined with the increasingly unpredictable actions of the European Commission has left Europe looking "dysfunctional and extreme", according to a leading Singapore-based derivatives lawyer.

Paul Landless, partner at law firm Clifford Chance, was speaking on a panel at the FIA Asia conference in Singapore yesterday, when he described the September 3 and October 2 decisions to provide conditional equivalency to a number of Asian states' clearing regimes by the European Securities and Markets Authority (Esma) as "fudged".

Esma has outlined a time frame of March 15, 2014 at the latest to decide whether third-country central counterparty (CCP) regimes in Australia, Hong Kong, India, Singapore and South Korea should be deemed equivalent. However Landless said it was impossible for this to be granted because European standards are so onerous.

"Esma fudged the process when it came up with the new idea of conditional equivalence, which basically means, 'they are sort of equivalent if these rules were tweaked'. When Esma writes its report to the European Commission it will say, 'we've looked at all the CCPs and none of them are equivalent – other than the Swiss'."

Landless said that even if all these regimes were given the green light for equivalence by Esma, there was no guarantee the European Commission would follow this advice in the light of its November 7 rejection of the supervisory body's plan to extend the time frame for implementing the trade reporting of exchange-traded derivatives – a move that had shocked the market.

"Europe is looking increasingly dysfunctional and extreme on all these issues and is being far harder than the US in its implementation of Dodd-Frank," Landless said. He added that in the CPSS-Iosco principles for financial market infrastructure, there already existed an international template for what a well-regulated CCP should look like and that by asking for higher standards Europe was "going rogue".

As a result of the Europeans' hard line, banks from that region operating in Asian markets faced being hit by punitive Basel III capital charges if they chose to clear through non-recognised regimes, Landless said.

"You might line up a bunch of subsidiaries in Asian countries, but good luck to you in terms of pricing once the regulatory capital charge has been applied," he argued.

Fellow panellist Gordon Perry, global derivatives adviser at Canadian law firm, Borden Ladner Gervais, said that in light of the upcoming Commodity Futures Trading Commission deadline for its substituted compliance ruling – the US version of equivalence – on a number of Asian countries, he would advise firms to look for non-US and European counterparties for over-the-counter derivative trades. "Why would you buy this regulatory uncertainty and this compliance nightmare when you have a number of potential counterparties which are not US and European to choose from?"

Given the major role both US and European banks provide in the Asian market, Perry's approach may provide challenges for dealers in Asia but according to Michael Syn, head of derivatives at the Singapore Exchange, the region has coped with such problems before and alternative sources of liquidity would be available over time.

"If there's a need for liquidity, in the medium term, markets will evolve to fill that gap – the concern would be what happens in the five-year interim period before it evolves. It would be exactly the same as what happened to local markets in the Asian financial crisis in 1998, and also what happened when Basel II was introduced. This isn't the first time these sorts of problems have emerged."

Syn said the positive aspect of an exit of US and European liquidity from Asia would be the catalyst effect it could provide for the development of interest rate markets around the region.

"In that interim period of five years when, let's say dollar liquidity disappears, CNH will emerge as a common currency, the Indonesian rupiah will come into use and those interest rates which are not influenced by Europe and the US will come into play," he said.