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Wall Street Notches Win Versus EU Derivatives Clearinghouses

Alexander Weber and Silla Brush

(Bloomberg) -- Wall Street banks and the world’s biggest money managers are starting to make headway in their campaign for tougher requirements on the clearinghouses that handle trillions of dollars of derivatives.

Diplomats from the European Union’s 28 member states said Wednesday that they’re in favor of a clearinghouse using a chunk of its own resources to cover the losses from a defaulted trade before resorting to financial contributions from its members.

JPMorgan Chase & Co. and BlackRock Inc., among other firms, have pleaded for such a requirement for years. The big clearinghouses owned by London Stock Exchange Group Plc, Intercontinental Exchange Inc. and CME Group Inc. receive collateral from traders to prevent the risk that a default by one party spreads throughout the system.

The EU is developing a broader push on how to handle a crisis in the industry, and clearinghouses will bear more of the burden.

The new tools will “help to address interconnectedness and contagion risks, while encouraging less risky behavior by clearinghouses and other market participants,” Finnish Finance Minister Mika Lintila said in a statement. Finland currently holds the EU’s rotating presidency.

‘Misalignment of Incentives’

Since the 2008 financial crisis, authorities from around the world have mandated that more interest rate, credit-default and other swaps be settled at clearinghouses instead of directly between buyers and sellers. Clearinghouses have boomed as a result. When one of their members defaults because of a busted trade or another problem, the non-defaulting members are typically required to contribute the financial resources to rebuild.

In October, firms including JPMorgan, Goldman Sachs Group Inc., BlackRock and Societe Generale SA published a paper arguing that clearinghouses need to have more “skin in the game.” Their shareholders get all the returns from clearing revenues, while bearing little of the risk from potential defaults, the financial companies argued. “It is therefore imperative that regulators take steps to address this misalignment of incentives,” they said.

The European Association of CCP Clearing Houses on Wednesday said the proposal was “unjustified” and put the EU out of step with international standards.

“It could potentially weaken risk management by making clearing more expensive and threaten the continuation of clearing services in some markets without any risk justification,” Rafael Plata, the group’s secretary general, said in a statement.

EACH’s members include clearinghouses owned by ICE, the LSE and Deutsche Boerse AG.

EU officials have indicated the issue has been controversial in discussions among member states. The compromise announced Wednesday makes clear that overall capital requirements for clearinghouses won’t rise as a result.

The legal proposal on how to deal with a crisis in the clearing industry was issued in 2016. Before the EU’s rules become final, the national governments have to reach a final agreement with the European Parliament, which has drawn up its own version of the law.

(Updates with clearinghouse comment in eighth paragraph)

To contact the reporters on this story: Alexander Weber in Brussels at aweber45@bloomberg.net;Silla Brush in London at sbrush@bloomberg.net

To contact the editors responsible for this story: Ambereen Choudhury at achoudhury@bloomberg.net, Marion Dakers

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