A conversation with Eric Pan, Director, Office of International Affairs, U.S. Commodity Futures Trading Commission (CFTC)
“Our concerns remain on the table”
The USA demand more hearings in the reform of the European Market Infrastructure Regulation Emir
The question of whether the European market supervisory authority ESMA will in future classify US clearing houses as systemically relevant and then also directly supervise them accordingly is a matter of concern not only for the US derivatives supervisory authority CFTC, but also for the US government. This says Eric Pan, Director of International Affairs of the CFTC. He considers it incomprehensible and unacceptable for large US clearing houses to be subject to direct supervision by ESMA. By Dietegen Müller, Börsen-Zeitung
The US derivatives supervisor CFTC hopes for an amicable solution in its discussions with the European Union over the supervision of systemically important clearing houses. Eric Pan, CTFC Director responsible for International Affairs, told Börsen-Zeitung that the reform of the European Derivatives Regulation Emir 2.2 is a "highly-sensitive" issue for the US, not only for the CFTC, but also for members of the US Congress and the White House. "We do not want this issue to become a source of conflict between the US and the EU," says Pan.
In mid-March, the EU Commission, together with the CFTC, published a joint statement on Emir 2.2 and declared that there should be a solution in which the respective local supervisory authorities should enjoy more respect (“deference”). "The dialogue between the CFTC and the Commission continues after the EU authorities reached a compromise on the regulatory text of Emir 2.2." Now the hot phase begins. "The details must now be worked out, and there are still many questions to be answered". The CFTC has heard from European decision-makers that they "fully understand" the position of the US, but it was very difficult to take these concerns into account at the statutory level of the reformed Derivatives Regulation (i. e. Level-1-Regulation) because of Brexit. "We think there have been some helpful changes, especially from the EU Parliament, but much remains to be done, and our concerns remain on the table," Pan adds.
EMIR 2.2 gives the European market surveillance authority ESMA extended powers to supervise third country CCPs classified as systemically relevant. CCPs are central counterparties that act as guarantors in a transaction between two counterparties. The CFTC had raised concerns that ESMA should not be granted full oversight of US CCPs. Pan had already told the Börsen-Zeitung last June that this was unacceptable.
Commitment by the European Commission
Based on discussions between the CFTC and the European Commission this year, Pan states that his expectation is that the concerns of the US side will be heard and taken into account during the development of the next phase of EMIR 2.2 legislation -- the Level 2 delegated acts. He also believes that Emir 2.2 will need time to be implemented such that US CCPs will not be subject to EMIR 2.2 until 2021 or later. "We believe that if Emir 2.2 is not properly applied, it has the potential to severely disrupt cross-border clearing between the EU and the US and negatively affect US businesses," Pan said. It would therefore be a good idea to use the available time in the coming year "so that both EU and US authorities can find solutions". Pan assumes that there will be a "real consultation" in which the opinion of the CFTC will be taken into account as announced in the joint statement. "The joint statement is not a commitment to a particular outcome, but it is a commitment by the European Commission to have an open attitude and to consider seriously the concerns raised by the CFTC", Pan specifies. "The CFTC position on EMIR 2.2 is not a political position. Rather, it is based on over fifteen years of experience supervising cross border CCPs and studying data ".
Assessment by the US government
A few months ago, CFTC Chairman J. Christopher Giancarlo threatened Europeans with access restrictions for European market participants if EU legislation did not take the desired direction. Pan confirms this in principle: "Senior members of Congress have encouraged the CFTC to take this position". Moreover, Giancarlo's successor, Heath Tarbert, has also taken this view. In a hearing, the designated CFTC Chairman declared that it would not be tolerable for US CCPs to be directly supervised by European supervisory authorities. “I cannot stress this enough: this is not an assessment by the CFTC, this is an assessment by the US government,” says Pan. “Our CCPs are supervised under US law, and the idea that a European supervisor could ignore US supervision and impose additional requirements and exercise direct supervision will not be acceptable to us."
But he sees no reason why this should happen at all. "Even our largest CCPs have a relatively small proportion of European business. We don't see why US CCPs should be treated as systemically important to Europe such that there needs to be direct EU supervision of those CCPs." Now it has to be determined what competence ESMA has been granted. "With great power comes great responsibility," Pan quotes the comic figure Spiderman. New regulatory hurdles and supervisory burdens that are unjustified would be against the interests of the global financial markets. "Further, this would also be against the interests of the EU as it seeks to be attractive for international players and be viewed as a leading financial market.”
Criteria for classification
Nevertheless, the classification of US CCPs by European supervisors remains a sticking point. "We have been told by some EU officials that they expect the major US CCPs to be classified as systemically relevant even though the overwhelming majority of business for these CCPs comes from U.S. banks and other US market participants and, relatively speaking, a small percentage of business derives from EU banks and EU market participants. We are still trying to understand what is the criteria for classification of systemically important. We are unsure why EU officials seem to already have decided on what will be the classification outcome when we do not yet even know the criteria to make such a classification." It is now a question of defining these criteria in a "transparent way" to make sure it is objective and evidence-based. ESMA probably has a lot of room for discretion to decide on the criteria, says Pan. "We can imagine ESMA treating systemically relevant British CCPs differently from US CCPs given the relative importance of British CCPs to the EU.
Pan also points out that by licensing foreign CCPs that conduct significant business with US clients, the CFTC itself has potential oversight capabilities such as carrying out on-site inspections of these foreign CCPs. But with the exception of certain British CCPs, the CFTC has never carried out an inspection of a foreign CCP, "because these CCPs do not pose a substantial risk to the US financial system, and we have traditionally deferred to the local supervisory authorities. We expect ESMA to do the same with US CCPs."
A definition of “deference”
The first foreign domiciled CCP to register with the CFTC was in 2001. At that time, the CFTC was one of only a few regulators to have a comprehensive CCP regime in place, and US law permitted the CFTC to require registration of foreign CCPs. Much has changed since then. Today, most regulators in key markets – especially EU – have quite sophisticated CCP regulatory and supervisory frameworks in place. In reflection of this fact, CFTC Chairman Giancarlo, in 2018, published a comprehensive review of the CFTC’s cross-border regime to more broadly defer to EU and other non-US authorities wherever possible. Pan also points out: "This is not only about clearing, but also trading venues, trade repositories, market conduct rules, and other areas”. This was the first time since the financial crisis that anyone inside the authority had taken a close review of CFTC regulations through a cross border lens. This was a necessary exercise to see where we could increase efficiencies and better align the outcomes of our post crisis reforms with their intended impact. Many European companies are affected by the CFTC regulation. The CFTC cross-border reforms aim to create clarity and certainty for these companies and makes it clear how the international supervisory authorities coordinate with each other," says Pan. The first new rule proposals from this review is expected to be published for public comment by June 2019 or perhaps earlier.
Pan also states it is important to understand how the CFTC defines deference. "Deference to other local regulators does not mean we will do nothing and ‘wash our hands’ of US clearing activity that happens outside of the United States. Rather, it means we will cooperate with authorities who engage in sound regulation and supervision of their domestic entities and rely on their oversight in instances where there is no systemic risk exposure." Such an approach requires a commitment to “outcomes-based deference.” Pan cites the example of different transparency criteria: "Hypothetically speaking, if we have ten different types of requirements but only eight in Europe, we may not insist on all ten if the extra requirements are not necessary for the mitigation of systemic risk. Where there is systemic risk exposure to the US, we will be more cautious and require compliance with more US requirements, but we will always coordinate closely with the entity’s primary home regulator to minimize regulatory and supervisory burdens for the entity".
Pan also draws attention to the question of the financing of ESMA’s new division focused on CCP supervision. "The fact that the competences for third country CCPs lie with ESMA is clearly laid out in the new legislation. But ESMA will need to hire more staff to do this, and this will be financed by fees received from the CCPs that ESMA supervises," Pan explains. "We have the strange situation where ESMA only supervises third country CCPs and so ESMA’s entire supervisory arm will be primarily financed by fees from US and UK CCPs. The idea that a foreign regulator is now asking US companies to fund most of its supervisory operations is something "that does not make people happy". If Brexit is delayed, it could happen that only US CCPs would pay most of the fees because British CCPs are still in the EU. "That would be a very strange result, which would be intolerable to the US. Depending on the number of new ESMA employees, it would cost several million euros more. That´s not an insignificant amount," says Pan.
No global crypto-asset standard
Asked about the lack of international regulation of so-called crypto-assets, i.e. digitalized assets on an encrypted basis, Pan says: "We need to understand how these different assets work. We are very active in this area and don't want to stand in the way of market development." It is good that different regulators are trying different approaches. "In our work in the international standardization bodies, we don't believe that the time is ripe to talk about uniform international standards for crypto assets," emphasizes Pan. "National standard setters should be free to try out their own approaches. We need to gain experience and see what works and what doesn't".