The CFTC and the European Commission (EC) reached a long-awaited agreement, under which the CFTC and the EU will each permit market participants to use one another's central clearing counterparties (CCPs) to satisfy its derivatives clearing requirements. While neither has adopted the equivalence determination yet, both plan to do so shortly. The accord is viewed as a big step towards global regulatory convergence.

Once passed, the EC equivalence determination will enable EU market participants to continue to satisfy EU derivatives clearing requirements by clearing swaps that must be cleared under EMIR with a CFTC-registered CCP (see Practice Note, EMIR: requirement to clear OTC derivative contracts through a CCP).

The EU equivalence determination is important for EU market participants because they can continue to use US CCPs (including CME Group, which clears some of the most popular derivatives contracts including Eurodollar futures and options) to clear certain swaps.

Chairman Massad of the CFTC announced that the CFTC will also propose a similar determination of comparability for EU CCP rules, which will allow EU-registered CCPs to provide clearing services to US market participants in satisfaction of CFTC rules requiring clearing of certain non-security-based swaps under the Dodd-Frank Act (see Practice Note, The Dodd-Frank Act: Swap Clearing and Exchange Trading under Title VII).

The European and CFTC swap clearing requirements are both based on international principles, and are therefore similar in many respects. The rulemaking bodies have stated that they will continue to work together to ensure that the regulations are harmonized and to discourage regulatory arbitrage.

EU equivalence must be sought by individual US CCPs, and requires that each CCP seeking EU recognition confirm that its internal rules and procedures ensure:

These conditions will not apply to US agricultural commodity derivatives traded and cleared domestically within the US, since that market has a low degree of interconnectedness with the rest of the financial markets. Therefore, to qualify for EU equivalence, US CCPs would need to confirm that its internal procedures govern the collection of initial margin for two-day liquidation periods on all derivatives except US agricultural commodity derivatives.

Once recognized as equivalent, a US CCP may serve EU markets and will become a qualifying CCP for purposes of the EU Capital Requirements Regulation (see Practice Note, Capital Requirements Regulation). EU banks that use these CCPs will now be able to avoid excess regulatory capital charges for holding positions under derivatives contracts with non-equivalent CCPs.

Before the EC determination becomes effective, EC member-state authorities must vote in the European Securities Committee, then ESMA must complete the process for recognizing US CPP applicants. Until then, US CCPs will be eligible for transitional relief that is available under the Capital Requirements Regulations.

The first phase of central clearing obligations for certain interest rate derivatives contracts under EMIR begins June 21, 2016. Until then, market participants may continue clearing contracts with non-recognized CFTC-registered US CCPs, including contracts entered into on or after February 21, 2016 that are subject to the frontloading obligation ("frontloading" refers to the requirement for certain derivative transactions to be cleared in accordance with the clearing obligation under EMIR where transactions are entered into during a given period before the clearing obligation takes effect).

EU and CFTC regulators anticipate that the recognition process will be complete and in place by the time the first EMIR clearing obligations become effective in June. US CCPs should therefore be able to provide uninterrupted service to their EU clients.

The EU also stated its plans to adopt:

Reactions from the industry to the agreement have been positive, with both ISDA and the ESMA supporting the regulatory harmonization and convergence.

For details on clearing mechanics for both the US and EU clearing models, see Practice Note, Mechanics of Derivatives Clearing.