US energy futures may be forced out of UK CCPs

Ice Clear Europe and LCH.Clearnet may not be able to offer clearing of US futures contracts in the UK after European clearing rules take effect, lobbyists are warning. The incoming regime requires a choice of segregation models that contradicts US rules

Conflicting transatlantic rules on the protection of client assets could force London's largest central counterparties (CCPs), Ice Clear Europe and LCH.Clearnet, to move clearing of US energy futures to their US arms. Currently, hundreds of contracts traded on US futures exchanges are being cleared in the UK.

The problem is that CCP members that extend clearing services to a wider array of clients have to register with the Commodity Futures Trading Commission (CFTC) as a futures commission merchant (FCM), and become subject to US rules on the segregation of client assets. They will also be subject to conflicting European rules when the clearing provisions of the European Market Infrastructure Regulation (Emir) take effect, which could happen late this year.

"At the moment, there is no efficient mechanism for working through these kinds of regulatory conflicts," says one senior futures industry lobbyist. "We know there is an ongoing dialogue, but my understanding is the CFTC was only made aware of the issue very recently. I'm certain this wasn't discussed during the recent discussions around the mutual recognition of trading platforms and CCPs. It's incredibly frustrating that a regulatory conflict with an obvious solution is being ignored."

The solution, he argues, is for Europe to provide a waiver to CFTC-registered FCMs that are clearing US contracts on European CCPs.

The issue arises because Emir requires clearing members to offer clients at least two forms of segregation: an omnibus model, in which assets are pooled to a greater or lesser extent with other clients, or individual segregation, in which clients have separate accounts. The former is theoretically less safe, but is also cheaper for clearing members to offer because it allows offsetting between client positions, translating into smaller net margin flows and lower funding costs for a clearing member.

At the moment, there is no efficient mechanism for working through these kinds of regulatory conflicts

The Dodd-Frank Act, however, requires FCMs to provide a single form of protection, known as legal segregation with operational commingling (Lsoc) – a twist on the omnibus approach. Individual segregation is deemed incompatible with US bankruptcy laws.

The result is that European clients wanting to trade US contracts while clearing in London will not be able to do so once Emir comes into force or that FCMs will need to breach Dodd-Frank and start offering two segregation models. The lobbyist argues European authorities hold the key.

"At the moment, there is only the option of giving FCMs some kind of formal exemption from their obligations to offer full segregation to clients under Emir, and simply allow them to offer Lsoc instead. The only other solution is for EU clients to stop trading those products, or for the CCPs to move clearing to the US," he says.

Ice Clear Europe and LCH.Clearnet failed to respond to requests for comment by press time.

Several hundred energy derivatives will be affected on Ice, stretching from Algonquin Citygates Swing Futures to Trunkline LA Basis Futures. These are cleared at Ice Clear Europe. Nodal Exchange, meanwhile, offers more than 1,200 different power futures contracts for a variety of local US power markets. All are cleared through LCH.Clearnet Ltd, the CCP's London entity.

For the CCPs, relocating clearing to the US is achievable, the lobbyist says – but clients and clearing members would need time to adjust. "If Ice was minded to move those contracts back to the US, it could probably do that relatively easily. I would imagine it's looked at doing that. But it would be a technological challenge for the firms themselves to make that happen. It's not something you can do in the space of a couple of weeks. If that's going to happen, we need to know as soon as possible," he says.