The Extraterritorial Regulation of Clearinghouses

Journal of Financial Regulation, 2016, 2, 2155
doi: 10.1093/jfr/fjw001
Advance Access Publication Date: 12 March 2016
Article
The Extraterritorial Regulation of Clearinghouses

Yesha Yadav* and Dermot Turing
ABSTRACT
This article argues that post-Crisis reform of over-the-counter derivatives is in trouble.
While regulators agree on the broad strokes of regulation, they diverge on the detail,
often on core issues like how clearinghouses should manage risk. In examining diver-
gences between the USA and Europe, this article makes three points. First, divergences
in clearinghouse regulation matter in derivatives markets because these markets are
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uniquely international in scope. Contracts involve counterparties in different countries.
Many transactions comprise cross-border aspects lacking a geographical anchor.
Where derivatives traders face legal uncertainty, they can be dis-incentivized from
observing laws or motivated to seek out the lowest cost compliance options. Secondly,
although the USA and European Union (EU) have adopted common ground rules,
their approaches to implementation differ in matters of detail. Such divergences pre-
vent regulators from recognizing each others clearinghouses as sufciently robust.
Thirdly, while acknowledging that mutual recognition is the most appropriate way for-
ward, substantial shortcomings exist with this approach. This article highlights continu-
ing areas of structural divergencelike access to emergency funding and bailouts
that impact the costs of the EU and US regimes. Where costs diverge, traders will seek
out avenues for regulatory arbitrage to lower costs of compliance. In concluding, this
article explores implications for reform.
K E Y W O R D S : nancial regulation; clearinghouses; systemic risk; extraterritoriality;
mutual recognition; collateral; DoddFrank Act; European Markets in Infrastructure
Regulation
I N TRO D UC T IO N
Few institutions have emerged from the financial crisis with as much prominence as
the clearinghouse. In response to the risks created by over-the-counter (OTC) de-
rivativeswidely blamed for intensifying the collapseregulators have entrusted
clearinghouses with the task of managing the risks created by these instruments.1
Rather than leaving individual firms to bilaterally agree on private solutions to risk
managementthe post-crisis regulatory approach looks instead to clearinghouses as
* Yesha Yadav, Associate Professor of Law, Vanderbilt Law School, 131 21st Avenue S, Nashville, TN 37203,
USA. Tel: 1 615-322-2615; Fax: 1 615-322-6631; Email: yesha.yadav@vanderbilt.edu.

Dermot Turing, Independent, Formerly, Partner, Clifford Chance LLP, 68 Marshalswick Lane, St Albans,
AL1 4XF, UK. Tel: 44 1727 760000; Email: dermotturing@btinternet.com.
1 The G-20 Pittsburgh Summit, Leaders Statement (2009) 9 <http://ec.europa.eu/commission_2010-
2014/president/pdf/statement_20090826_en_2.pdf>. But see, Rene M Stulz, Credit Default Swaps and
the Credit Crisis (2010) 24 J Econ Persp 73.
C The Author 2016. Published by Oxford University Press. All rights reserved.
V
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21
22 Journal of Financial Regulation
the major safeguard against the risks created by OTC derivatives.2 Firms can no lon-
ger make promises to one anotherundertakings that can easily unravel under
stress. Instead, they must contract through a clearinghouse. With a clearinghouse
underpinning the completion of deals in the derivatives market, firms can rely on a
strong, safe, central buffer that can deliver on the promises that it makes.
By any measure, clearinghouses face a daunting challenge post-crisis. While esti-
mates vary as to its size, the Bank for International Settlements (BIS) places the value
of the OTC derivatives market at approximately $670 trillion on a notional basis at the
end of 2013.3 This market is also profoundly international. To cite just one example,
of all the credit default swaps (CDS) outstanding globally, just 19 per cent are con-
cluded with counterparties located in the home country. Put another way, CDS traders
conduct business with counterparties outside of their own jurisdiction at more than
four times the rate than they do with those at home.4 The size and international scale

of the OTC derivatives market raises the stakes for global policymakers as they put the
final touches on their cure for its riskiness. Not only must regulators develop robust,
common standards to govern trading in OTC derivatives, but this framework must
also extend to cover the clearinghouses that have been tasked with managing their
risks. Indeed, the costs of failure are enormous. By becoming the central counterparty
(CCP) for the near $700 trillion global trade in OTC derivatives, a small number of
clearinghouses are set to concentrate risks on an internationally systemic scale.
Ineffective coordination in oversight between global policymakers clearly has the po-
tential to place the global financial system in serious peril.
This coordination challenge is significant in the context of derivatives clearing-
houses, tasked with taking on risks emanating from all corners of the global market-
place. OTC derivatives traders (unlike dealers trading in organized markets) enjoy a
choice in deciding where to trade. This gives them a say in determining the jurisdic-
tion where they want to transactand importantly, in the clearinghouse they would
like to use. A trading firm will rationally look for the jurisdiction where the compli-
ance costs are lowestwhich will include an assessment of where the obligation to
clear can be met most cheaply. The international nature of derivatives market means
2 Atlantic Council Divergence Report, 2931 http://www.atlanticcouncil.org/images/publications/Danger_

of_Divergence_Transatlantic_Financial_Reform_1-22.pdf. On the historically bilateral nature of the mar-
ket and the risks of this design see, Bushan Jomadar, The ISDA Master Agreement - The Rise and Fall of
a Major Financial Instrument (2007) Westminster Business School, Working Paper <http://papers.ssrn.
com/sol3/papers.cfm?abstract_id1326520> (analysing the OTC market and the contractual framework
governing transactions); Frank Partnoy, ISDA, NASD, CFMA, and SDNY: The Four Horsemen of
Derivatives Regulation? (2002) University of San Diego School of Law Public Law and Legal Theory
Working Paper, Paper No 39 <http://papers.ssrn.com/sol3/papers.cfm?abstract_id293085>.
3 Bank For Intl Settlements, Statistical Release: OTC Derivatives Statistics at End-June 2013 (November
2013). The notional basis of a contract is one way of measuring the relative size of the market and gener-
ally refers to the gross value of the contract. Exposures may also be measured on a net basis. Notional prin-
cipal is not the same as the value at risk, particularly in relation to an interest rate derivative. The value at
risk on an interest rate swap is based on the difference between the fixed and floating rate measures of
interest, which is likely to be a percentage (or more likely a fraction of a percentage) of the notional princi-
palie the amount of the imaginary loan on which the floating and fixed interest amounts are calculated.
Accordingly, the headline notional principal numbers, which are quoted in publications to grab attention,
may if misunderstood exaggerate the size of the risk.
4 Bank For Intl Settlements, ibid, 1011.
The Extraterritorial Regulation of Clearinghouses 23
that many transactions may not have any obvious geographical anchor. Consider, for
example, a Swiss bank that enters into a fixed-floating interest rate swap on a no-
tional principal amount expressed in British Pounds, where its counterparty is the
New York branch of a Japanese bank. Such a transaction may be documented under
New York law and supported by collateral that includes German Government bonds
held in Euroclear (which is located in Belgium and operates under Belgian law). If
one or other party to this imaginary transaction is subject to a clearing obligation, it
will be necessary to identify a clearinghouse that will accept the transaction. And for
a vanilla transaction type such as a GBP interest rate swap there are likely to be sev-
eral clearinghouses contending for the business. Since there may be no obvious geo-
graphical link between the transaction and its originators and any particular
clearinghouse, clearinghouses and market participants are likely to have a choice
(subject to overriding legal rules) as to whether and where to conduct clearing activ-

ities. How market participants make their choices is impacted by regulatory and legal
differences, including cases where rules do not specifically target clearing as such but
which apply nonetheless, creating uneven incentives in the regulatory system.
This article shows that post-crisis oversight of clearinghouses is falling short of its
goal of reducing the risks of trading OTC derivatives. A patchwork of rulemaking
and a failure to coordinate between national authorities threaten to place the regula-
tory project under critical strain. Not only does this state of affairs heighten the risks
of regulating derivatives and their clearinghouses, but it also highlights the deeper fis-
sures underpinning the deliberative process in international financial regulation.
Most obviously, domestic regulators have diverged in their implementation of the
international consensus governing clearinghouses. International regulators, notably,
the Bank for International Settlements Committee on Payments and Market
Infrastructures and the International Organization of Securities Commissions
(IOSCO) have led efforts to create international agreement on key principles for
overseeing market infrastructure like clearinghouses.5 However, this consensus leaves
much detailsome of it significantto be filled out by national legislation.
Focusing on the USA and the European Union (EU), we show that domestic regula-
tors have diverged, sometimes sharply, in the transposition of international standards
on clearinghouses in national legal systems. EU and US legislators, while giving effect
to the internationally agreed consensus, differ on granular questions concerning the
regulation of derivatives clearinghouses. For example, the European Securities
Markets Authority (ESMA) has noted that the US approach to regulation of deriva-
tives clearing organizations (DCOs) falls short of European standards in the follow-
ing respects:6
Risk Committee requirements;

Business continuity requirements;
5 Bank For Intl Settlements and IOSCO, Principles for Financial Market Infrastructures (CPMI
Principles) (April 2012) http://www.iosco.org/library/pubdocs/pdf/IOSCOPD377.pdf, replacing the
Recommendations for Central Counterparties (November 2004).
6 European Securities and Markets Authority, Technical Advice on Third Country Regulatory Equivalence
under EMIR US ESMA.2013/1157 (1 September 2013) (ESMA Equivalence Assessment).
Margin requirements;
Default fund requirements;
Other financial resources requirements;
Liquidity risk control requirements;
Default waterfall requirements;
Collateral requirements;
Investment policy requirements; and
Review of models, stress testing, and back testing requirements.
While that list might, if taken at face value, imply that EU standards of regulation
are superior to those in the USA, it is important to note that it was not within
ESMAs mandate to study any areas in which EU law falls short of US regulation.
Indeed, there are numerous areas of policy where US requirements seem much more

stringent, such as in relation to the amount and quality of collateral that clearing-
houses must receive. In sum, however, failure to agree on matters of detail means
that there are important differences between the two economic regions in the areas
of margin, default-risk management, financial backstopping, and governance. On ac-
count of these differences, the EU and USA impose varying costs on their domestic
clearinghousesand, by extension, on the firms that ultimately use these clearing-
houses for their derivatives trading. As it currently stands, both sets of regulators are
caught in an impasse: each considers its own system of regulation to be superior to
any other.7
These differences matter. Local law variations in the regulation of clearinghouses,
and the routine absence of a geographical anchor in international trades, pose a di-
lemma for regulators: namely, if US and EU laws both apply, can regulatory differ-
ences be overcome to allow the transaction to be cleared by a single clearinghouse
authorized either by the USA or the EU? Or, must it be cleared by a clearinghouse
authorized by both the USA and the EU? Or, where clearinghouses cannot comply
with the duelling demands of both the EU and US laws, must the trade be cleared
twiceonce through a US clearinghouse and again through an EU clearinghouse
(and if so, how could this be done?)? These dilemmas lead to further questions for
regulators. Where US law differs meaningfully enough from EU law, will US firms
using EU clearinghouses be viewed by US regulators as falling short of the optimal
standards of risk-managementand vice versa? And, if this the case, will US regula-
tors subject these US firms to further compliance requirementsincreasing their
basic costs versus their EU-based competition? From the point of view of market
participants, these unresolved questions create legal uncertainties that cannot easily
be factored into the cost of doing business. For derivatives like CDSwhere around
80 per cent of trades involve counterparties outside of the home statelack of clar-
ity over the home country for the transaction creates the potential for duplicative
compliance, non-compliance, or even selective breach by trading firms.8 These
7 Joe Rennison, U.S. Superior to Europe on Futures Margin Financial Times (14 May 2015). See also,
Committee on Capital Markets Regulation, Letter: European Union United States Need to Resolve
Differences Between their Clearinghouse Requirements (28 January 2013).
8 Atlantic Council Divergence Report (n 2) 4036.
challenges may lead traders to shirk their obligations or to find creative ways around
them.9 Compliance uncertaintyand its resulting costs for firmsmight increase
the appeal of keeping derivatives outside of central clearing altogether.
Relatedly, international clearinghouses, seeking to maintain their global client
base, also confront a slew of commercial, legal, and operational risks. Faced with
competing regulatory environments, securing recognition only under the US or the
EU regime jeopardizes the ability of international clearinghouses to clear cross-bor-
der, transatlantic trades. Insofar as EU and US laws impose varying obligations (eg
with respect to the amount of quality of collateral that clearinghouses should keep),
international clearinghouses seeking to maintain their cross-border operations can
try to resolve these differences by complying with the higher standard or by breach-
ing regulations owing to compliance uncertainties. These legal problems also create
concerns from the perspective of risk-management. Clearinghouses unable to confi-

dently clear trades from a large number of clients may be restricted in their ability to
engage in the netting of trades to reduce the amount of money that any single client
owes to another (and thus to the clearinghouse that stands as CCP and guarantor).
They will likely have access to a more diminished reserve of collateral and lower rev-
enue sources from which to bolster their own equity capital base. Clearinghouses
may also fail to properly supervise clients and the risks entering their own institution,
particularly if clients slice up their cross-border trades or are strategic about how
they structure them, to comply with EU and US rules. Notwithstanding some fairly
intractable differences in legal regime, some international clearinghouses are seeking
to win recognition under both the EU and the US regime. US clearinghouses are
seeking authorization from EU regulators, and EU clearinghouses are looking to gain
authorization or exemption from US regulators from compliance with the Dodd
Frank Act (DFA). While this posture clearly makes sense from the point of the clear-
inghouse, it risks imposing duplicative costs on clearinghouses in excess of what may
be optimal for risk management. Indeed, though some clearinghouses may be look-
ing for dual-authorization, others are holding off, waiting to see how US and EU
regulators might ultimately resolve their differences.10
In seeking to deal with this problem, regulators and commentators have offered a
form of mutual recognition as the obvious solution.11 Under this regime, national
regulators recognize each other laws as providing an acceptable level of protection.
Once national regulators agree on the suitability of each others laws, they can give
credit to firms that comply with the laws of any accepted country. Applied to
9 Gabriel Rosenberg and Jai Massari, Regulation Through Substitution as Policy Tool: Swap Futurization
Under Dodd-Frank (21 April 2013) Working Paper http://papers.ssrn.com/sol3/papers.cfm?abstract_
id2256047 (discussing the trend among firms to convert swaps into futures trades).
10 See, eg CME Europe, FAQ: CME Inc. QCCP Status and Standing in Europe https://www.cmegroup.
com/clearing/files/faq-ccp-final.pdf; Davis Polk, Impacts and Implications of the CFTCs Emerging
Clearinghouse Exemptive Program (21 January 2015).
11 See, eg John Morrall III, Determining Compatible Regimes between the U.S. and the E.U. US Chamber
of Commerce Working Paper https://www.uschamber.com/sites/default/files/legacy/reports/
Determining%20Compatible%20Regulatory%20Regimes.pdf (on general issues of regulatory compliance
between the EU and the USA); Press Release, Commodity Futures Trading Commission, The European
Commission and the CFTC Reach a Common Path Forward on Derivatives (11 July 2013) (detailing
the importance of equivalence in determining regulatory action and recognition in derivatives regulation).
derivatives regulation, where clearinghouses are subject to acceptable national rules,

they can be widely relied on to clear international trades in satisfaction of the post-
crisis clearing mandate.
Mutual recognition offers a multitude of benefitsand, indeed, presents the most
probable solution to the problem of diverging national legal regimes for clearing-
houses under the USA and the EU. Ideally, clearinghouses authorized under the laws
of a recognized jurisdiction need comply with only a single set of home-country na-
tional laws. Market participants can satisfy the mandate to centrally clear OTC de-
rivatives by using any one of these authorized clearinghouses, avoiding duplicative
clearing obligations where counterparties are located in different jurisdictions.
Indeed, the system as a whole can emerge stronger where legal clarity leads to clear-
inghouses attracting a large numbers of trades. High trade volumes can boost the
ability of clearinghouses to monitor risks across a large swathe of the market, to pro-

vision for this risk through rich reserves of capital and to generate revenues that sup-
port their operations.
This article moves to show, however, that mutual recognition is difficult to apply
in practice, and in any case does not remove the risks posed by the extraterritorial
regulation of OTC derivatives and clearinghouses. This argument is salient not just
for EU and US regulators but also more generally in relation to international deriva-
tives regulation as a whole. For one, key aspects of regulation, such as availability of
bailouts and crisis funding for clearinghousesas well as the intensity of supervision
to which they will be subject, are likely to remain. Taken together, divergences be-
tween legal regimesand mutual recognition of these differencesleave open the
possibility that market participants will look for lowest-cost compliance environ-
ments for their trades. Clearinghouses might choose to domicile in jurisdictions with
the lightest regulatory burden, for example, in terms of the capital buffers that they
must keep, availability of credit, or the monitoring they confront. Where clearing-
houses face less stringent scrutiny regarding how they provision for the risks they as-
sume, they can gain incentives to clear problematic but profitable contracts at the
expense of broader systemic safety. With the small number of clearinghouses in oper-
ation, any single weak link can create significant damage, where low costs attract
international business and foster reliance by counterparties and regulators.
Moreover, divergences between legal regimesnotwithstanding mutual recogni-
tionplace a high responsibility on national regulators being able to coordinate and
overcome national competitive interests to meet a common goal. Mutual recognition
and reliance on home state regulators to supervise clearinghouses ensures that na-
tional economies around the world are reliant on home state regulators to perform
this function effectively. The enormous costs of clearinghouse failure combined with
its cross-border repercussions suggest that no single jurisdiction is likely to have ei-
ther the incentive or the resources to manage it alone. Furthermore, national regula-
tors may be willing to overlook risks posed by their domestic clearinghouses to
champion their business and to draw trading volume into the local financial system.
In such cases, mutual recognition offers only an incomplete remedy to bridge diver-
gences in national approaches to default resolution and risk sharing between financial
market participants.
This article proceeds as follows. The Significance of Clearinghouses in Financial

Markets section provides an overview of the role of clearinghouses, their key tools for
risk mitigation, and significance for financial markets following the financial crisis. The
Turn to Clearinghouses in Post-crisis Regulatory Reform section describes areas of
key difference in the national legal regimes governing clearinghouses in the USA and
the EU. It moves to analyse the implications of these divergences under each of the
US and EU regimes. The Mutual Recognition in Practice section discusses mutual
recognition, its potential for resolving the risks of divergence as well as the lingering
risks left outstanding. The major obstacle to mutual recognition remains uncertainty
over the scope of each regulators jurisdiction. Finally, the Some Implications section
concludes with some observations on possible solutions to consider in refining current
regulatory initiatives to contend with the outstanding issues.
It is worth briefly articulating the central objectives of this article. At its broadest,

the article reflects upon a significant problem in post-crisis international financial
regulation: the risk of fracture and fragmentation between countries in the imple-
mentation of the G-20 consensus on regulatory reform. While countries have coa-
lesced around a shared set of solutions to the problems afflicting financial markets in
the years leading up to the crisis, putting these ideas into practice in domestic legal
systems has proven far more contentious. This article illustrates this phenomenon by
examining the diverging approaches adopted with respect to the regulation of clear-
inghousesinstitutions that have acquired a prime role in ensuring that the interna-
tional financial system operates safely. Focusing on EU and US regulation, this
article shows that divergences in rulemaking between these jurisdictions risks ser-
iously undermining the primary goal of securing global financial stability. It moves to
critically examine solutions, notably, mutual recognition and to outline policy path-
ways for future reform. In seeking to illustrate the problem of post-crisis regulatory
fragmentation through the prism of the clearinghouse, the approach of this article is
necessarily restricted in scope. We cannot examine the many divergences that under-
lie implementation of the G-20 agenda across the financial system. Even with respect
to clearinghouses, we can survey only a small subset of the rules that affect their op-
eration and risk management. Ultimately, while limited in its scope, we hope that
this analysis provides an overview into a significant dilemma impeding the imple-
mentation of an agreed regulatory goal, narrowly with respect to clearinghouses, and
broadly with respect to the G-20 regulatory agenda. In this regard, we hope it can
offer some contribution to fixing a profound fissure emerging in the application of
the post-crisis consensus.
T H E S I G N I F I C A N C E OF C L E A R I N G H O U S E S I N F I N A N C I A L M A R K E T S
The rationale for clearinghouses
Clearinghouses occupy a central place in our financial system. From 1880 onwards,
clearinghouses have evolved into powerful institutions that underpin trading in de-
veloped financial markets.12
12 Franklin R Edwards, The Clearing Association in Futures Markets: Guarantor and Regulator in Ronald
W Anderson (ed), The Industrial Organization of Futures Markets (1984) 225; Craig Pirrong, If Its So
Great . . . Streetwise Professor (22 November 2008) <http://streetwiseprofessor.com/?p984>.
Their goal is simple: to reduce the risk of contract party default. Any trader might
contract with another to enter into a derivatives transaction. Ordinarily, there is little
guarantee that the trader will have the funds or the willingness to come through and
fulfil the terms of the bargain. Without some kind of reassurance that the transaction
will complete, parties face uncertainties when trading. Such fragility can create perva-
sive and widespread costs for markets. Market participants will adjust their pricing to
take account of the risk of counterparty default. Liquidity will suffer when only the
hardiest of firms can afford to trade. Most importantly, markets will fall short of ful-
filling their promise as efficient intermediaries of capital between investors and in-
vestments where participation costs are unreasonably high.
Clearinghouses provide a solution to this problem. In modern markets, clearing-
houses become the CCP to financial market trades.13 Once two traders strike a bar-
gainthe buyer agrees to purchase a financial instrument from a seller at a set

pricethe clearinghouse interjects to legally become the buyer to each seller and
the seller to each buyer. The clearinghouse achieves this through a process called
novation. Described simply, the clearinghouse breaks the contract between the buyer
and the seller and creates two new contracts in its place: (i) one between itself and
the buyer; and (ii) another between itself and the seller.14 It becomes the CCP to
this trade, legally obligated to perform on the deal vis-a`-vis both the buyer and the
seller. If one or other of the parties walks away, the clearinghouse must fulfil the
terms of the contract, even if this performance comes at a cost to the clearing-
house.15 Clearinghouses are essential to the smooth functioning of derivatives mar-
kets.16 Clearinghouses provide essential underpinning, providing confidence to the
market in OTC derivatives, which are the focus of this article, and additionally sup-
port trading in all manner of securities, including stocks, bonds, as well as common
derivatives long traded on public exchanges, like futures and options.
Clearinghouses represent a private-ordering solution to the costs of counterparty
risk. Large financial institutionsdeeply embedded users of securities and financial
marketshave historically been at the forefront of establishing and operating clear-
inghouses. Broadly speaking, the clearinghouse institutionalizes their shared effort to
systematically reduce the risks of trading. Under the aegis of the clearinghouse, large
financial firms come together to pool funds and to stand (through the operation of a
mutualized default fund) as, in effect, guarantors of each others trades. If one mem-
ber fails to perform on its obligations, for example, if it has gone into bankruptcy,
others step in to cover any shortfalls. Crucially, the clearinghouse should offer a
stronger buffer against the spread of risk than any single institution by itself. The
clearinghouse should possess a deeper reserve of funds, collateral, and information
13 Yesha Yadav, The Problematic Case of Clearinghouses in Complex Markets (2013) 101 Geo LJ 387,
40613 (discussing in detail the CCP function of the clearinghouse).
14 CFTC Rule 39.12(b)(6). This rule prescribes the novation process for US clearinghouses.
15 Craig Pirrong, The Economics of Clearing in Derivatives Markets Netting, Asymmetric Information, and
the Sharing of Default Risks through a Central Counterparty Univ. of Houston, Working Paper
<http://papers.ssrn.com/sol3/papers.cfm?abstract_id1340660>.
16 The CME clearing reports clearing around $1 quadrillion worth of trades annually. The CME is among
the major exchanges that trade common commodity and financial derivatives. For discussion see
<http://www.cmegroup.com/clearing/>.
with which to come to the aid of a defaulting member and also to police its own
risk-taking.17 From the perspective of clearinghouse users, an institution backed by
the leading and largest financial institutions should attract high volumes of business
and generate strong revenues for the clearinghouses members.
The costs of managing clearinghouse risks

Clearinghouses confront enormous costs in the performance of their functions. Put
bluntly, they insure against the mistakes and failures of financial institutions across
the marketplace. When a member institution fails, a clearinghouse can be left holding
catastrophic levels of risk on its books. If the clearinghouse cannot meet the obliga-
tions of the failed member firm, for example, if the clearinghouse does not have the
funds on hand, the impact can reverberate across the marketplace. When a member
defaults on its obligations, and a clearinghouse cannot follow through, this failure

causes losses for other market participants who lose the benefit of their bargains and
may themselves end up closer to default.
To safeguard against this possibility, the clearinghouse utilizes a number of tools
to reduce its risks. While a full discussion of these risk mitigation mechanisms is out-
side the scope of this article, a few bear highlighting. These are: margin (collateral)
arrangements, default funds (including access to public sources of liquidity), and
governance norms that incentivize safer decision-making by traders and clearing
firms. These mechanisms are briefly summarized below.
Collateral
Clearinghouses require that their members secure their obligations to the clearing-
house by providing collateral (or margin) to reflect the risks they pose for the clear-
inghouse. For each trade, members offer some security to the clearinghouse in the
form of assets that the clearinghouse can sell to pay for any liability that might arise
on default. The safer, more liquid the collateral, like cash or government securities,
the surer the protection for the clearinghouse. Highly liquid collateral can be sold
quickly to meet the immediate obligations of a clearinghouse on a members default.
Clearinghouses generally specify what kind of collateral they accept (eligible collat-
eral), how frequently it is collected, and how the clearinghouse manages the assets
that it collects as collateral. Some clearinghouses are willing to accept a broader range
of collateral than others, including cash and treasuries as well as shares or bonds that
may be more difficult to value in times of stress.18
Providing collateral is not always desirable for members. In addition to paying
fees to the clearinghouse, members must hand over coveted, lucrative assets that the
member might wish to invest elsewhere.19 While collateral requirements force
17 For discussion of the potential of risk-taking in this regard, see, Yadav (n 13) 41620.
18 Standard and Poors, the rating agency, considers reflecting these changing eligible collateral requirements in
the ratings they give clearinghouses. The stricter the collateral requirements mandated by clearinghouses, the
greater the chances that the clearinghouse will better handle default. For discussion, Margin for Error: Why
not all Clearinghouse Collateral is Created the Same (December 2012) Standard & Poors http://www.stand
ardandpoors.com/ratings/articles/en/us/?articleTypeHTML&assetID1245346070203.
19 Clearinghouses often invest the collateral to recoup gains from the assets. In other words, they may invest
the treasuries, shares, or bonds to generate profit that can be distributed between members or to those
members to better internalize the costs of their risk-taking, the expense generates
incentives to shirk use of the clearinghouse or to figure out ways to reduce collateral
burdens. Particularly for derivativeswhere contracts can mature over months or
even yearscommitting collateral can extract a heavy price.20 Members might wish
to see the clearinghouse adopt a broad definition of eligible collateral to reduce their
private costs of doing business.
Default fund
In addition to providing collateral on a continuous basis to support their trades, clear-
inghouses generally require their members to contribute to a default fund. The default
fund generally represents a deep pool of assets that can be tapped into to secure the
obligations of the clearinghouse in case a members existing collateral account is insuf-

ficient. The default fund represents a shared resource reflecting the collective contribu-
tions of clearinghouse members. In this manner, it illustrates the function of the
clearinghouse as an institution that pools the risks of its membersan attempt at
mutualizing their losses if these are beyond the capacity of any single member.21 As
with on-going collateral contributions, assets placed in a default fund for the clearing-
house constitute an expense for members. They cannot easily extract assets from this
fund in case of need, nor can they invest them for their own gain. Instead, default fund
contributions are locked into the clearinghouse to support its robustness against mem-
ber default, and can be regarded in effect as a form of special-purpose capital.22
Default waterfall
Clearinghouses establish clear procedures to govern default and the failure of a mem-
ber firm. Members agree to submit to these procedures in advance of joining the
clearinghouse. This pre-commitment offers members and outside traders clarity re-
garding the resolution of failure within the clearinghouse, the distribution of losses
between members and, with this, the likely costs that any single member might face
in case of anothers default.
An efficient resolution process within the clearinghouse lies in the order by which
losses are internalized and shared between members. This tiering of lossesknown as
the waterfalldescribes the layers through which the clearinghouse absorbs the costs of
failures. Clearinghouses might vary in the steps they follow when dealing with member
failure. But, typically, the process looks first to the members reserve of collateral with
the clearinghouse to deal with any shortfalls. If this collateral is insufficient, the waterfall
next moves into the default fund to secure further cover against liabilities. The default
fund may be structured in tranches, with more senior layers the last to pay out.23
that own the clearinghouse. Such investment strategies can create risks for clearinghouses if they cannot
then easily liquidate the securities. For a fuller discussion, see Standard and Poors, ibid.
20 See, eg <http://www.cmegroup.com/clearing/financial-and-collateral-management/>.
21 See, eg NASDAQ OMX, Default Fund, <http://www.nasdaqomx.com/transactions/posttrade/clearing/
europeanclearing/risk-management/default-fund>.
22 Basel Committee for Banking Supervision, Capital Requirements for Bank Exposures to Central
Counterparties (July 2012) < www.bis.org/publ/bcbs227.pdf>.
23 See, eg NASDAQ OMX, Waterfall <http://www.nasdaqomx.com/transactions/posttrade/clearing/euro
peanclearing/risk-management/default-fund/waterfall>.
To minimize the losses the clearinghouse faces and to slow the pace by which the
waterfall is utilized, clearinghouses are usually permitted by law to net all outstanding
obligations owed by or to a defaulting member. Rather than force members to pay
out the full gross amount of any payment, netting reduces the upfront cash demands
on members. This can be illustrated by a simple example. If failed Member A owes
the clearinghouse $100 and the clearinghouse owes Member A $50, Member A need
only have $50 cash on hand to pay the clearinghouse. If liabilities were to be ex-
pressed on a gross basis, Member A would be on the hook to pay $100 and to expect
that the clearinghouse would have $50 to pay Member A. By netting the amounts
owed by and to members, the clearinghouse should see a far lower drain on its avail-
able liquidity, reducing the chances of member collateral and default fund reserves
being used up by the shock of member failure.24
For these measures to be effective, rules and regulations must be in place to pro-

vide the basic legal framework within which clearinghouses can operate successfully.
As exemplified by the USA and the EU, legal regimes set the basic regulatory param-
eters that govern clearinghouse operations, ensuring that the exercise of the clearing-
houses powers is supported by national laws. Regulators set basic rules governing
how much collateral clearinghouses should demand, the quality of this collateral, and
its management. They also ensure that the clearinghouse can legally seize and sell
this collateral if it needs to do so. The law may aim to ensure that any netting and
set-off that occurs under the clearinghouses default procedures is effective against
challenge.25 This is no small accommodation. Netting and set-off rules for the clear-
inghouse can bring major gains to financial counterparties that, through this process,
acquire payment priority over other creditors in bankruptcy.26
Governance
A robust governance framework is essential to the clearinghouses ability to manage
risk and police the conduct of its members and customers. Traditionally, clearing-
houses have been administered by their members. In other words, those that supply
the clearinghouses default fund have historically also overseen its administration and
governance functions.27 This model assumes that member institutionshaving the
most to lose in case of a clearinghouses failurewill faithfully safeguard the clearing-
house against excessive risk-taking by customers as well as by other members. Some
clearinghouses continue to use this conventional model. In the case of equities trad-
ing, the Depository Trust and Clearing Corporation, a leading US clearinghouse
24 But see, Mark Roe, Clearinghouse Over-confidence Project Syndicate (26 October 2011) http://www.
project-syndicate.org/commentary/roe6/English; Mark J Roe, Clearinghouse Overconfidence (2013)
101 Cal L Rev 1641, 166162; Craig Pirrong, The Clearinghouse Cure (200809) Regulation 4647;
Craig Pirrong, Derivatives Clearing Mandates: Cure or Curse? (2010) J App Corp Fin 50.
25 S 560 of the US Bankruptcy Code stipulates that a master agreement is a protected contract under the
Code. S 362(b)(17) excludes derivative counterparties (those that are counterparties to a protected con-
tract) from the restrictions of the automatic stay on the enforcement of claims.
26 Roe (n 24).
27 Pirrong (n 12); Randall S Kroszner, Can the Financial Markets Privately Regulate Risk? The
Development of Derivatives Clearinghouses and Recent Over-the-Counter Innovations (1999) 31 J
Money, Credit & Banking 596, 598604.
responsible for clearing most US-traded equities operates on a member-owned

basis.28 But, increasingly, the industry has moved towards a shareholder-owned ra-
ther than member-owned model. Today, clearinghouses are often owned as part of
large corporate groups comprising numerous exchanges and international clearing-
houses. Parent companies of clearinghouses can be publically listed and traded, as in
the case of Chicago Mercantile Exchange Clearing (CME Clearing) and clearing-
houses operated as part of the Intercontinental Exchange group.29 This form of own-
ership places governance in the hands of investors who may lack expertise in risk
management and whoby being diversified, or not active in the risk-generating
activities which constitute cleared businessmight have less on the line than mem-
bers in case of clearinghouse failure. Still, shareholders also bring benefits, particu-
larly in the form of large amounts of investor capital that can offer clearinghouses
deeper buffers against default than reliance on a default fund alone.

The factors which may influence a market participants decision as to whether
(and if so where) to clear a trade are likely to depend strongly on the clearinghouses
approach to risk management and its cost. This presents a trade-off. Risk manage-
ment techniques lead to the clearinghouse taking collateral from members, and oblig-
ing members to contribute to a default fund. These obligations entail cost but deliver
safety. However, the factors that affect a market participants choices are not limited
to those relating to the cost and quality of risk management. Other issues that are
likely to be taken into account include the clearinghouses financial resources. This
capital is important because it provides a cushion against losses that might otherwise
be shared out among members. Governance is closely related to resources. If mem-
bers provide the resources that the clearinghouse will utilize following a default, it is
to be expected that the members will wish to supervise, and possibly even to control,
the clearinghouses approach to risk management. A clearinghouse whose risk con-
trol is firmly in the hands of non-member shareholders who have little skin-in-the-
game may not be popular with members even if it is run cheaply and efficiently.
Clearinghouses thus represent a private solution to the problem of counterparty risk.
Their failure necessarily risks catastrophic costs to the entire financial system, nationally
and globally. Recognizing their public significance, a detailed framework of regulations
underpins clearinghouse operations. As discussed with reference to the USA and the
EU, the design of national regulatory regimes fundamentally shapes how a clearing-
house manages its risk and the costs it and its members face in doing so.30
T HE TU RN TO C LE A RI N GH OU SE S IN P O ST -C RI S IS R EG UL A TOR Y
REFORM
The international consensus on central clearing
Despite their history, clearinghouses have only recently emerged into the spotlight in
the wake of the financial crisis. Indeed, precisely because of their longstanding
28 The Depository Trust Company, Response to the Disclosure Framework for Securities Settlement
Systems (2002) 89.
29 See, eg Clearing, CME Group, http://www.cmegroup.com/clearing/; See also, Yesha Yadav,
Clearinghouses and Regulation by Proxy (2014) 42 Ga J Intl & Comp L 1.
30 Richard Squire, Clearinghouses as Liquidity Partitioning (2014) 99 Cornell LR 857, 86366.
contribution to safe, well-functioning derivatives trading, international regulators

have converged upon clearinghouses as offering the most effective solution to the
problem of counterparty risk in derivatives traded over-the-counter.31
OTC trading in derivatives, notably in CDS, has been blamed for contributing to
the collapse of the financial markets in 200708epitomized by the rapid failure of
the American International Group (AIG).32 A full discussion of the role of CDS is
outside the scope of this article. But the sudden demise of AIG and the scrutiny sub-
sequently cast on CDS brought into relief the challenges posed by the large, com-
plex, and international over-the-counter derivatives market.33
Markets in futures, equities and bonds are tightly regulated, with high degrees of
price transparency, exchange trading rules, and central clearing. The same cannot be
said for the OTC derivatives markets. Specializing in swaps like those referencing
interest rates, currencies, and credit, the OTC market has offered a space for the larg-

est and most sophisticated financial firms to trade with one another off-exchange
with markedly lower levels of regulatory scrutiny. In the USA, for example, specific
legal dispensation by Congress in 2000 under the Commodities and Futures
Modernization Act (CFMA) carved out regulatory room for sophisticated, well-capi-
talized financial firms to transact with one another outside of most regulatory over-
sight.34 The Act prohibited the Commodities and Futures Trading Commission
(CFTC) and the Securities and Exchange Commission (SEC) from regulating
swaps. With only limited anti-fraud authority over certain security-based swaps, the
SEC and the CFTC could not otherwise impose reporting, disclosure, or clearing re-
quirements or require that these contracts be traded on exchanges. Unfettered from
these more conventional safeguards, the OTC market could flourish and expand in
size. For example, the Bank of International Settlements reported that the OTC mar-
ket grew at an annual rate of 32 per cent between 2004 and 2007 at the height of the
pre-crisis boom years.35 It offered a venue where firms could enter into complex, tail-
ored transactions using bilaterally agreed provisions regarding collateral and default.
Without mandatory exchange trading and reporting of trades, parties could transact
with limited transparency, precluding systematic assessments of the risk inhering in
the OTC space.36
The unravelling of financial markets in 200708 focused attention on the OTC
market and the need for institutionalized risk management to undergird its activities.
31 The G-20 Pittsburgh Summit (n 1).

32 But see, Stulz (n 1) (arguing that derivatives did not cause the crisis).
33 See, eg Committe on Capital Markets Regulation, The Global Financial Crisis: A Plan for Regulatory
Reform (2009) 48 http://www.capmktsreg.org/pdfs/TGFC-CCMR_Report_%285-26-09%29.pdf; On
the mechanics of OTC trading see, Jomadar (n 2).
34 It should be noted that the CFMA represented an attempt to bring clarity to a legal landscape that
included numerous prior pieces of legislation that sought to exempt certain swaps from exchange trading
and central clearing. For example, the Futures Trading Practices Act 1992 and the subsequent CFTC
Swap Exemption 1993 offered an exemption for certain swaps from regulation under the Commodity
Exchange Act. S 2(d) CFMA 2000.
35 Bank For Intl Settlements, Triennial Survey: Positions in the Over-the-Counter Derivatives Market at
End 2010 (November 2010) 23.
36 Lynn A Stout, Legal Origin of the 2008 Financial Crisis (2011) UCLA School of Law, Law-Econ
Research Paper No 11-05. On the industry-standard master agreements devised by trade associations like
the International Swaps and Derivatives Association (ISDA), see Partnoy (n 2).
While the international consensus forged between regulators has not called for an
outright dismantling of OTC trading, it has prompted call for a deep structural re-
organization centred around the institution of the clearinghouse. Rather than leave
individual firms to negotiate their own rules as to risk management and trade report-
ing, regulators believe that clearinghouses should clear and report trades on behalf of
market participants. Private firms will no longer have to worry that their counterparty
might default. Instead, the clearinghouse will bring its long-cultivated expertise in
risk management, assessment, and oversight to anchor derivatives trading on a surer
footing. Agreed between G-20 global regulators, the move to mandatory clearing of
formerly OTC derivatives represents a coordinated effort to impose common stand-
ards across borders. At least in theory, international regulators, working in lockstep,
should prevent the creation of any single jurisdiction where limited oversight attracts
risky trade and attempts by firms to evade the reaches of the law.

In the sections below, we examine key issues underlying the transposition of the
G-20 agenda into the US and EU law. We demonstrate that US and EU regulators
diverge in critical areas relating to the rules governing risk management by clearing-
houses. Notably, regulators vary in their local rules relating to collateral, default fund
rules, and on the broader institutional oversight to which clearinghouses will be sub-
ject. These differences are deeply significant. They lead to distributive consequences
where market participants face changing costs depending on the jurisdiction in which
they clear their contracts. More worryingly, they open up areas of legal uncertainty
that can undermine credibility in the post-crisis framework for OTC derivatives
reform.
The creaky consensus: the US approach

The USA has transposed the G-20 agreement on financial regulation primarily pursu-
ant to the DFA.37 Title VII of the DFA sets out a new framework for the regulation
of OTC derivatives. Repealing earlier legislation curbing the authority of the CFTC
and the SEC in relation to swaps, section 723 of the DFA stipulates that swaps that
have been approved for clearing must be subject to central clearing using an
approved clearinghouse. Significantly, only clearinghouses that have been recognized
by the CFTC are authorized to clear swaps for US persons, even if a non-US coun-
terparty is involved.38 The CFTC can exempt certain clearinghouses from this regis-
tration requirement if it is regulated by a legal system with a comparably robust legal
regime.
The CFTC specifies a detailed set of qualifying criteria that clearinghouses must
meet in order to be recognized as qualified to clear OTC derivatives for US per-
sons.39 First, all derivatives clearinghouses must, as a minimum, comply with the
CFTCs Core Principles on clearinghouses. These Core Principles span all major
37 DoddFrank Wall Street Reform and Consumer Protection Act of 2010, Pub L No 111203, Title VII
(codified in sections of 7 USC and 15 USC).
38 S 722, DFA.
39 These criteria are set out, notably, in Derivatives Clearing Organization General Provisions and Core
Principles, 76 FR 69334 (8 November 2011); Derivatives Clearing Organizations and International
Standards, 78 Fed Reg 72476 (2 December 2013). The DFA references clearinghouses as DCOs. See
also, s 725(c), DFA 2010.
aspects of a clearinghouses operation and organization, such as safety and sound-

ness, governance, and risk management.
Clearinghouses must also comply with a more detailed set of rules under part 39,
subparts A and B. Importantly, clearinghouses that are deemed to be systemically
significant by US federal regulators must comply with additional criteria under part
39subpart C. If clearinghouses comply with Subparts A and B and the additional
criteria in Subpart C, they are deemed to be qualified CCPs. Compliance with
Subparts AC should mean that a clearinghouse is comprehensively and intensively
regulated. Because of this robustness, the law allows members of a qualified CCP to
enjoy a regulatory benefit. Members can get significant deductions in regulatory cap-
ital charges when they clear their trades using a qualified CCP. Non-systemic clear-
inghouses can opt-in to this more intensive supervisory regime for systemic
institutions, in order to give their members the cost savings involved with using a

qualified CCP.40 Non-systemic clearinghouses can thus become Subpart C
Derivatives Clearing Organizations even if their operations are not strictly systemic
in nature.41 In developing these rules, the CFTC faced criticism from international
actors regarding the viability of an opt-in regimethat is, a regime that allows a
smaller clearinghouse to choose to become a qualified CCP, rather than automatic-
ally being designated as such (and then maybe showing that it should not be one).
An opt-in regime can give smaller clearinghouses the choice to operate under a laxer
regulatory regime. For international actors, this choice is problematic, where it leaves
smaller clearinghouses capable of housing risks that may bleed into the wider inter-
national financial system.
A full discussion of Part 39 criteria and detailed differences between the EU and
the US regimes is beyond the scope of this article. Still, focusing on key aspects of
clearinghouse risk mitigation regulation yields insights regarding important differ-
ences between their jurisdictions. These include rules relating to the collateral that
clearinghouses must collect and keep, the reserve funds that they must keep under
the default fund, as well as the procedures to be put in place to manage the failure of
member firms. Invariably, the criteria stipulated by the CFTC and the SEC impact
the costs that clearinghouses face in establishing their operations to centrally clear
derivatives trades.42
Gross margin
The CFTC requires that the clearinghouse collect margin from its members on be-
half of customers. Interestingly, the CFTC requires that the clearinghouse collect
40 http://www.cftc.gov/IndustryOversight/ClearingOrganizations/index.htm; Derivatives Clearing Organizations

and International Standards, 17 CFR parts 39, 140, and 190. In addition to parts A and B, clearinghouses that
are systemically important must also comply with subpart C.
41 It is worth noting that part 39, subparts AC, and particularly subpart C is intended to give effect to inter-
national principles agreed by the Basel Committee on Payment and Settlement Systemsthe Principles
for Financial Markets Infrastructures (PFMIs). For more, see, Committee on Payment and Settlement
Systems and the Technical Committee of the International Organization of Securities Commissions,
Principles for Financial Market Infrastructures (April 2012) http://www.iosco.org/library/pubdocs/
pdf/IOSCOPD377.pdf; Basel Committee on Banking Supervision (n 22). See also, s 805(a)(2)(a), DFA
2010; CFTC, Derivatives Clearing Organizations and International Standards (Final Rule) 912.
42 See also, Atlantic Council Divergence Report (n 2) 40.
sufficient margin from its members to reflect the gross positions for each customer,
not on a lighter net basis. This means that margin demands must reflect the full,
gross position of a customer, imposing a high outlay on those seeking to clear
trades.43 The alternative approach would be for members to collect margin for cus-
tomers on a net basis. Members could offset the positions of one customer against
those of another, and post margin to the clearinghouse to cover the difference. The
requirement that margin be calculated on a gross basis is especially significant from
the perspective of derivatives trades. Importantly, derivative contractsnotably
swapscan extend across months and years. Where margin requirements are deter-
mined on a gross basis for swaps, customer capital is locked in for a potentially
lengthy period of time.44
The requirement that customers post margin on a gross, rather than on a net,
basis fulfils both an ex ante as well as an ex post risk management function. From the

ex-ante perspective, net margining mutualizes risk among customers of a member, ra-
ther than among members. This means that customers are sharing the risks of their
transactions with one another and fully provision and pay for that risk through cus-
tomer margin. By contrast, a default fund mutualizes risk between members of a
clearinghouse because members supply the collateral as a condition precedent to
their participation. By forcing customers to share risks with one another and to in-
ternalize the costs of their trading, regulation can nudge better risk-consciousness on
the part of clearinghouse customers. Those that come to the clearinghouse should be
more careful about what deals they wish to do because they will have to fully cover
the cost of their exposures through a gross margin requirement. From the ex post
perspective, clearinghouses that can access gross customer margin are likely to have
fuller reserves of collateral to access in case of distress. Of course, gross margin re-
quirements can have serious downsides as well. Gross margin requirements can
make central clearing expensive. This cost may disincline customers from using clear-
inghouses or to seek out ways to reduce their daily costs to the clearinghouse.
US regulators place significant weight on the desirability of gross margin rules as a
central mechanism for protecting the clearinghouse. According to CFTC Chair
Massad, robust gross margin requirements may actually be a more essential element
43 CFTC r 39.13(g)(8)(i); CFTC r 39.13(g)(8). Under these rules, the clearinghouse is prohibited from
netting the positions of its customer accounts for the purposes of determining margin.
44 The purpose of initial margin is to protect the clearinghouse against losses if the member fails. The clear-
inghouse will need to close out the members non-performing contract, and the costs of doing so should
be covered by the initial margin. The question of net margining arises frequently in the case of cleared
OTC derivatives. Take an example: a member has entered into a five-year interest rate swap where it has
the position of floating-rate payer in respect of a notional principal of 10 million dollars. Six months later
the member enters into another interest rate swap of 4 years duration in respect of a notional principal of
12 million dollars, and on this occasion it acts as fixed-rate payer. The two transactions will partially but
not completely offset. The clearinghouse demanded initial margin of $750,000 for the first swap and
would expect initial margin of $600,000 for the second (if that second swap were the only trade in the
members portfolio). If the clearinghouse allows for netting, its margining algorithm might allow the
member to receive back some part of its $750,000 margin already posted. Whereas if the clearinghouse
margins on a gross basis, no offsetting benefit will be allowed and the member will post the extra
$600,000 margin in full. A final comment may be made on gross versus net margining. Where client
transactions are recorded in a single, multi-client omnibus account, the opportunity for net margining
arises because more transactions have the potential to offset at the clearinghouse level.
to systemic safety than those governing the clearinghouses member-supplied default

fund. Put another way, requiring that customers post higher margin for their trades
does a more thorough job of curtailing and provisioning for risk-taking than simply
forcing financial institution members to supply ever-thicker levels of collateral for the
default fund. For one, customer margin usually constitutes a far larger proportion of
overall margin held by a clearinghouse than that comprising the default find. High
levels of customer margin can mean that the clearinghouse has a deep, ready reserve
of collateral to access in the event that a clearinghouse is in distress. Importantly, a
clearinghouse that can cover shortfalls using customer margin may do a better job of
saving itself in a crisis. By using customer margin to manage its risk, the clearing-
house can avoid eroding other financial sources, notably the default fund as well as
shareholder capital. An important benefit of maintaining these institutional buffers
lies in the signalling that it can provide to the market more broadly. A clearinghouse

that can avoid accessing its default fund can show that it remains viable, potentially
reducing panic and motivating customers to continue to clear trades with it.
Importantly, securing default fund, cash and share capital in a clearinghouse can mo-
tivate other clearinghouses to take over a failing clearinghouse. As noted below, EU
law allows customer margin to be posted on a net basis. Given the reliance that US
regulators appear to place on gross initial margin as a risk management mechanism,
this difference may be a source of considerable tension between the US and EU
regimes.45
Financial resources on default

Margin is recognized to be collected in amounts that are not sufficient to cover all
losses. Covering losses with margin measured by reference to a 99 per cent confi-
dence interval means that, for one in every 100 days, market prices will move outside
boundaries for which collected margin is sufficient. Additional default backing is
needed, and so all clearinghouses must have sufficient financial resources to be able
to cover obligations to members following the failure of the member to which the
clearinghouse has the largest exposure. This requirementcalled the cover one re-
quirementmeans that all clearinghouses should be able to cover the failure of the
single member posing the greatest risk to the clearinghouse in extreme but plausible
circumstances.46
For some systemic clearinghouses, however, the CFTC goes further. Systemic
clearinghouses with international operations or with a complex risk profile must
keep sufficient resources to withstand the failure of the two clearinghouse members
posing the greatest risk in extreme but plausible stress conditions. This cover two
requirement significantly raises the resources that these clearinghouses must keep.47
Interestingly, the cover two requirement does not apply to all systemically import-
ant clearinghousesonly those with meaningful international operations (eg where
international regulators might consider that clearinghouse as systemically risky) or
with a complex risk profile. This means that some systemically risky clearinghouses
45 Remarks by Chairman Massad (n 84).

46 S 5b(c)(2)(B)(ii)(I) of the CEA, 7 USC 7a-1(c)(2)(B)(ii)(I).
47 Derivatives Clearing Organizations and International Standards (n 39).
can continue operations under a cover one regime if the scale of their international
operations or overall complexity falls short of CFTC thresholds.48 The distinction
between cover one and cover two systemically important clearinghouses clearly im-
pacts the resources and relative competitiveness of clearinghouses vis-a`-vis both do-
mestic and international counterparts. Non-US regulators might have cause for
concern where large, systemic clearinghouses are not deemed to fall under the
CFTCs cover two threshold. However, if international regulators are concerned, it
is probable that the clearinghouse has a sufficiently complex and global profile to be
subject to the more exacting cover two requirement.
The CFTC also regulates the liquidity of clearinghouse assets. Subpart C clearing-
houses must maintain sufficiently liquid assets to withstand the intraday obligations
of the clearing member that creates the largest liquidity exposure for the clearing-
house. Critically, this requirement focuses on ensuring that clearinghouses possess

extremely liquid collateral to deal with the immediate, same-day obligations owed to
clearing members.49 The CFTC adopts a stringent but still fairly flexible definition of
the kind of collateral that clearinghouses may accept, particularly for satisfying the li-
quidity requirement under Part 39.50 In short, the collateral must be readily available
to the clearinghouse to sell in case of catastrophe. Clearinghouses cannot depend on
some future ability to make payments. Rather, they must be able to make immediate
payment based on the security available to them. This means that more contingent
claims, like unfunded lines of credit, corporate bonds, or shares are unlikely to qualify
as eligible collateral. Clearinghouses cannot fully rely on their authority over clearing
members to demand future assessments to cover the obligations of the
clearinghouse.51
The rationale underpinning a stringent collateral standard is clear. Clearinghouses
should be failure proof. They should have enough financial resources to survive a
major shock to the institution. Through these demands, members as well as the
clearinghouse provide significant financial reassurance to match the size and extent
of their risk-taking. With tougher collateral standards, necessitating that deeply li-
quid, non-contingent, marketable securities (or cash) be provided, the credit quality
of a clearinghouse should be uncontestable. With full confidence in its abilities, clear-
inghouse members may be less likely to exit their commitments and cancel their con-
tracts at the slightest sign of trouble. More fundamentally, such security should keep
losses arising from failure cabined within the clearinghouse itself rather than liable to
spread outwards into the financial system as a whole.
Institutional backstops
A further rationale might animate the emphasis on high-quality, failure-proof col-
lateral: the limited chances of clearinghouses benefiting from bailouts under the
post-DFA regime. Clearinghousesparticularly those that are designated as
being systemic by federal regulatorscan access credit lines supplied by the
48 17 CFR 39.11(a)(1).
49 Ibid 39.14.
50 Ibid 39.14 (c)(1)-(4).
51 Ibid 39.11(d)(2)(iii) and (iv).
Federal Reserve in case of need. In other words, they can for emergency credit
under the Feds discount window.52 The supply of emergency funding by way of
collateralized loans is not a bailout. The DFA prohibits single US clearinghouses
from being bailed out. No matter their systemic significance, the sudden collapse
of an individual clearinghouse cannot (technically) benefit from a bailout from
the Fed. Indeed, commentators worry that access even to emergency credit lines
for clearinghouses is likely to be controversial. Political pressures in the wake of
the crisisreflecting concerns about taxpayer assistance for failing financial insti-
tutionsmight weigh against the provision of discount window lending facilities
to clearinghouses.53
When the DFA sets strong ex post constraints against emergency liquidity for
clearinghouses, it is understandable that the CFTC should seek to establish tough
rules on the financial resources that clearinghouses must keep. Notwithstanding this

emphasis on ex ante provisioning, the effectiveness of CFTC rules rests on clearing-
houses making correct calibrations of the risks they face and the capital they need. A
challenge here, however, lies in the incentives of the clearinghouse to maintain deep,
expensive pools of financial resources to cover its risks. In particular, clearinghouses
faces complex tensions. Their operations depend on continuous flows of trades to
generate fees. This implies a business model demanding little from members by way
of margin and default fund contributions. Thus clearinghouses face incentives to
underestimate the risks on their books, particularly to reduce the resource costs on
customers. Short-termism in clearinghouse risk management may be more likely
where access to ex post liquidity is limited. In such cases, a troubled clearinghouse
may be motivated to focus on short-term profitability in the belief that its chances of
surviving a rare but catastrophic default are limited.
While there is a risk that some market participants will favour a cheaper but less
robust clearinghouse, others will prefer to clear at a clearinghouse that has best-of-
breed risk management notwithstanding the extra cost. The latter preference is likely
to be expressed by those participants that have the most to lose from a major default:
in other words those participants who are most heavily exposed to default funds. In
an ideal world, such participants should ensure that their preferred clearinghouses
have strong policies with regard to margining and default cover. To guarantee that
this remains the case, such participants are likely to also examine the governance ar-
rangements at the clearinghouse in order to ensure that like-minded participants are
in effective control of risk management. Governance and ownership are thus critical
components for ensuring that risk-management differentials between clearinghouses
do not destabilize clearing systems by allowing low-cost high-risk providers to be-
come established and build critical mass.
52 Ss 8044 DFA. For discussion, Colleen Baker, The Federal Reserve as Last Resort (2012) 46 Mich JL
Reform 69, 97104 (arguing that the Federal Reserve plays a new role under the DFA as the lender of
last resort in financial markets, raising the need to develop solutions to moral hazard).
53 See, eg http://blog.thomsonreuters.com/index.php/clearinghouses-default-waterfall-offers-no-panacea-
against-their-potential-failure/. However, as Professor Baker notes, the flexibility of the Federal Reserves
role as Lender of Last Resort is likely to permit sufficient flexibility to provide assistance if necessary.
Baker, ibid.
The EU approach
The principal legislation in the EU that governs the regulation and conduct of clear-
inghouses is the European Market Infrastructure Regulation (EMIR).54 As an EU
Regulation, EMIR constitutes directly binding law in all 28 Member States of the
EU, and thus is superimposed on a widely diverse group of legal traditions, local
laws, regulatory rulebooks, and soft law. Consequently, most Member States in
which clearinghouses were already established in 2012 already had legal and regula-
tory systems in place to address issues relevant to clearing; EMIR has forced some
change to these pre-existing practices (since EU Regulations prevail over local law by
virtue of the Treaty on the Functioning of the EU55). Since EMIR has to fit with
many different approaches to clearing, as well as the diversity of legal approaches, it
is sometimes framed in rather general terms. EMIR is also supported by subordinate
EU legislation, in particular, a set of Regulatory Technical Standards promulgated

by the pan-European regulatory bodies ESMA and the European Banking Authority
(EBA). Despite these differences, the purpose of EMIR will be familiar: to imple-
ment the section of the post-crisis agenda that was designed to make clearing of basic
OTC derivative products mandatory.
The principal chapters of EMIR relevant to derivatives clearing can be summar-
ized as follows. Title II imposes a clearing obligation in relation to OTC derivatives
declared subject to the clearing obligation by ESMA. It also sets out related duties
of parties to derivatives transactions, notably reporting, collateralization, confirm-
ation, for example. Title III sets out the rules for licensing of clearinghouses, and sets
out parameters for cooperation among (primarily EU Member State) regulators.
Title IV contains the main regulatory provisions of EMIR with respect to clearing-
houses, with rules on governance, ownership, business continuity, outsourcing, mem-
bership criteria, segregation, porting (described further below), margin, default
funds, liquidity management, default management, reinvestment of assets, stress-test-
ing, and more. These chapters contain provisions explaining how EMIR applies to
non-EU clearinghouses seeking to do business with EU persons.
Margin
In relation to OTC derivatives, European law specifies56 that initial (original) margin
must be calculated on the basis of a 99.5 per cent confidence interval and a five-day
liquidation period.57 The law also specifies what data and what look-back period
should be used to guide the calculations. These rules approximate to those applicable
in the USA for derivatives clearinghouses. As to eligibility of collateral, EMIR states
that collateral must be highly liquid with minimal credit and market risk.58 It stops
54 Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC
derivatives, central counterparties, and trade repositories.
55 OJ C115 vol 51, 47.
56 Regulatory Technical Standards, Commission Delegated Regulation (EU) No 153/2013 of 19 December
2013 supplementing EMIR (the CCPs RTS), arts 24(1) and 26(1).
57 The liquidation period is the time expected for the clearinghouse to close out the defaulters positions so
as to quantify any loss. In broad terms, a 99.5% confidence interval indicates that there is a 99.5% chance
that price movements during the liquidation period will be covered by the margin.
58 EMIR, article 46(1).
short of setting out a list of approved collateral or a blacklist, thereby leaving the ac-
tual choice of collateral to the clearinghouses themselves. However, supplementary
rules regulate haircutting, concentration limits, and the institutions with which collat-
eral may be held in custody. In its assessment of US regulatory standards,59 ESMA
noted that the USA had not adopted various detailed restrictions, notably that the
USA (unlike Europe) permits the acceptance of letters of credit as a form of collat-
eral.60 For futures, the USA specifies a liquidation period of only one day whereas
the EU specifies two days.
In several respects, the US approach might be more flexible than its European
counterpart. On the other hand, it would appear that the US requirement for margin
to be posted on a gross basis for customer accountsin contrast with Europe, which
permits net margining of omnibus client accounts, when accompanied with suitable
risk disclosure to the clientscould substantially increase the cost of clearing client

business at a US clearinghouse.
Financial resources on default

EMIR states that the default fund must be large enough, together with other pre-
funded available financial resources (which do not include assets representing the
clearinghouses minimum regulatory capital61), to enable the [clearinghouse] to
withstand the default of at least the two clearing members to which it has the largest
exposures under extreme but plausible market conditions.62 This appears similar to
US cover two requirements discussed above but at least, on this measure, stricter
than US cover one rules. A further rule in EMIR states that the default fund must
enable the [clearinghouse] to withstand, under extreme but plausible market condi-
tions, the default of the clearing member to which it has the largest exposures or of
the second and third largest clearing members, if the sum of their exposures is
larger.63 EMIR requires that the contributions to the default fund be proportional to
the exposures of the clearing members.64 Beyond this, it is left to the discretion of
clearinghouses to set the criteria and calculation methodology. Thus, the clearing-
house has discretion to set a default fund size somewhere between cover two and
cover one (for this reason, it is sometimes called cover-one-and-a-half), and to fill
the gap using other pre-funded financial resources, such as assets representing add-
itional capital or some species of collateralized credit insurance.
One might conclude from this that a US clearinghouse not deemed to be sys-
temic would have a smaller default fund than an EU clearinghouse, or that an EU
clearinghouse could have a smaller default fund than a systemic US clearinghouse,
or (based on the analysis conducted by ESMA) that any US clearinghouse may have
a very limited default fund, which is actually paid up ex ante. Any of those
59 ESMA Equivalence Assessment (n 6).

60 Ibid, Annex III, 136.
61 EMIR is confused and inconsistent on capital. Some provisions of EMIR are drafted as if capital was
somehow an asset. The authors have editorially construed art 43 so that financial resources means assets
of the clearinghouse and capital is a requirement for a minimum amount of such financial resources.
63 Ibid article 42(3).
conclusions might imply that either the EU or the USA has superior risk manage-
ment standards. A further factor to throw in is that the default fund is not the only
source of strength once the margin is exhausted: the clearinghouse may, and under
EMIR must, have an amount of non-member-funded financial resources available
(so-called skin-in-the-game). That may plug an apparent gap if quantified in a risk-
based manner (which is not so in Europe, as discussed below). To sum up: the sys-
tems are different; but it is hard to say definitively that the one is decisively worse
than the other.
Default waterfall
EMIR spells out (incompletely) a set of rules on the default waterfall, that is to say
the order of application of assets to cover losses experienced by a clearinghouse on a
member default. The relevant rules are as follows. Prior to any other financial re-

sources, the clearinghouse must use the margin posted by a member.65 Then, where
the margin posted is not sufficient to cover the losses, the clearinghouse must use
the defaulting members own default fund contribution.66 It is implicit in this obliga-
tion that no other financial resources may be utilized at this stage of the loss-cover-
age process. Thirdly, the clearinghouse may not have recourse to the default fund
contributions of non-defaulting members until it has both exhausted the defaulters
contribution and utilized a prescribed amount of dedicated own resources, equal to
25 per cent of its minimum capital (meaning shareholders funds).67
Apart from these three hard rules, the clearinghouse is given more discretion
about the order and manner of utilization of resources. For example, it is open to the
clearinghouse to utilize other financial resources in priority to non-defaulters default
fund contributions, or to apply default fund contributions in some scheme other
than pro rata loss-sharing. It is open to the clearinghouse to pass round the hat68 or
to write down the entitlements of members or even to shut up shop altogether, al-
though it is implicit in the statement that a clearinghouses default fund is to limit its
credit exposures to its clearing members69 that the default fund is actually to be
used. In any event, the flexibility of the EMIR rules enables clearinghouses to choose
from a wide range of default funding models to cover losses that are not contained
through utilization of margin.
As to quantum, there is a difference from US standards: EMIR has a dual test for
default fund size. In both the USA and the EU, the fund must be sized so as to with-
stand the default of the member to whom the clearinghouse has the largest exposure.
But, additionally, the European Union requires that the default fund be large enough
to withstand the defaults of the second and third largest members if in aggregate
these exposures are larger than the largest.70 Further, ESMA concluded in its assess-
ment of the US regulatory regime for DCOs that the CFTC permits a default fund

67 Ibid article 45(3) and (4); CCPs RTS (n 56) article 35.
to be left partly unfunded.71 Europe would appear to be a safer but costlier place to
clear on this analysis.
However, the picture is not so simple. Although a large default fund may have
attractions, notably that it implies that the clearinghouse has a robust ability to
withstand defaults, it is not necessarily the ideal structure for a backstop. Members
may prefer that backstopping be provided from shareholders funds, rather than
the mutualized-risk default fund. The reason lies in the regulatory capital treatment
for members in respect of their funded contributions to a default fund. This is an-
other area in which EU practice diverges from that of the USA and the rest of the
world.
Regulatory capital is the minimum amount of shareholders funds that a financial
institution must have to cushion against losses. The amount of regulatory capital is
calculated by adding up the risk-weighted exposures of the institution. When a mem-

ber contributes to the clearinghouses default fund, it places resources at the disposal
of the clearinghouse. A contribution to a default fund is a type of exposure for the
clearinghouse and will therefore require the member to keep some regulatory capital
to account for this added risk to its books.
The EUs Capital Requirements Regulation72 sets out the relevant rules for banks
and investment firms (which will include clearinghouse members) prudentially regu-
lated in the EU. In relation to regulatory capital for default fund contributions, the
Capital Requirements Regulation is more stringent than the Basel 3 standard.73
Both Basel 3 and the EU regulatory capital rules prescribe the amount of regula-
tory capital that a member must hold in relation to its contribution to a default fund.
The clearinghouse is set a target amount of hypothetical capital to be raised from
the default fund and other sources. So, the greater the ability of the clearinghouse to
utilize shareholders funds or other resources not contributed by members to meet
this target, the lower the capital cost for members for their default fund
contributions.
However, the implementation of this principle is different in the detail in Europe,
where there is not one formula, but three regimes of increasing severity depending
on the amount of the clearinghouses non-member resources. Where the clearing-
house has a high target and low non-member resources, the relevant regime is
harsher than the Basel standard and might even be considered penal.
Clearing members will be incentivized to choose a clearinghouse that involves
minimal regulatory capital cost, and so may favour clearinghouses with substantial re-
sources not funded by members. For European banks and investment firms,
the (Color online) structure of the default waterfall may be less important than the
relative sizes of the member-funded and non-member resources given the potentially
harsh cost of the alternative.
When considering the possible resources available to a clearinghouse following a
default, it is tempting to assume that the funds of the central government might be
71 ESMA Equivalence Assessment (n 6) Annex III, 122.

72 Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on pru-
dential requirements for credit institutions and investment firms, etc (CRR), article 308.
73 Basel Committee on Banking Supervision, Capital Requirements for Bank Exposures to Central
Counterparties (April 2014) paras 20408.
available for a bailout. Regular pronouncements from the authorities attempt to dis-
abuse all stakeholders of this. Regulators are, instead, working on methodologies that
are intended to keep an ailing clearinghouse afloat without the need to depend on
public funds. Recovery and resolution plans are now being expected from clearing-
houses in Europe, and regulatory rules to implement the policy are not far away.
Meanwhile, clearinghouses have adopted a number of recovery tools in their rule-
books, such as variation margin gains haircutting and member obligations to top-up
the clearinghouses resource pool. It may be noted that these tools invariably place
the cost and risk of catastrophic failure on the community of members. There is, dis-
appointingly, only limited discussion about whether members actually should pay
when the failure is in part attributable to deficiency of the clearinghouses own risk
management system. That question may ultimately prove to be more important than
microanalysis of whether default funds should be sized at cover one, cover two, or

cover-one-and-a-half, or left partly unfunded, or indeed any other points of compara-
tive detail.
Other backstopping
In addition to the requirement for a certain amount of dedicated own resources,
which is a form of skin-in-the-game to be supplied from sources other than member
contributions, the requirements for an EU clearinghouse to have capital (ie share-
holders funds, not including members contributions to the default fund) are few. A
clearinghouse must have a permanent and available initial capital of at least EUR 7.5
million.74 Further shareholders funds are required to backstop business risks, which
are not those associated with the core clearing business, such as operational and legal
risks and credit and market risk encountered otherwise than in the context of the
cleared transactions. It is thus important for members of EU clearinghouses to have
a voice in the risk management of the clearinghouse. EMIR specifies that a clearing-
house must have a risk committee composed of representatives of members, inde-
pendent board members, and representatives of clients. Its mandate is to advise the
board on any arrangements that may impact the risk management of the
clearinghouse.
Although ESMA observed that the CFTCs risk committee requirements for DCOs
are not equivalent to EMIR,75 the differences would appear to be non-material. One
factor that ESMA did not consider was whether it is appropriate for the owners of a
clearinghouse to be a different class of persons from its members and indirect users.
The investment objectives of independent owners may be quite different from those
of a fully mutual clearinghouse where the members are also (either themselves or
through affiliates) the providers of its shareholders funds. The two different ownership
models may require different approaches to assessment and sharing of risk, a question
that EU legislation declines to consider.
In contrast to the USA, the EU possessespotentiallymore room to man-
oeuvre in the matter of access to emergency liquidity support from the central bank.
EMIR does not constrain national regulators in their ability to offer emergency

75 ESMA Equivalence Assessment (n 6) Annex III, 72.
support to clearinghouses.76 However, it does not necessarily empower them either.

For the most part, national central banks in EU Member States have discretion in
how fully they wish to support their domestic clearinghouses with credit lines or bail-
outs. This suggests thatat first glancenational EU regulators can react flexibly to
deal with emerging crises in relation to clearinghouses. Still, from the perspective of
US regulators, this state of affairs is awkward. Giving discretion to national EU cen-
tral banks could intensify crises where action is stymied through a lack of coordin-
ation, funds, or strategic cost shifting to other regulators. Short of clear procedures
directing national central banks in the exercise of their powers vis-a`-vis clearing-
houses, a lack of procedural certainty might constitute a source of worry for clearing-
houses and markets.

Does sufficient harmonization exist?
The discussion set out above shows that significant differences in regulatory ap-
proach exist between the EU and the USA.
As regards risk management in clearinghouses, however, it is difficult to conclude
that one system is evidently weaker or stronger than the other. Both systems are
founded on a common belief that clearinghouses should have strong margining ar-
rangements backed up with default funds and other structures that give them access
to liquidity and resources when large-scale defaults occur. To ask regulators to go be-
yond this common ground and specify in great detail the minutiae of clearinghouse
risk management would be counterproductive. Clearinghouses would be denied the
ability to adapt their models to changed circumstances or pursue innovative ideas.
Competition for improvements in risk management is, ultimately, healthy and
wise.77
Unfortunately, regulators in both regions may be tempted to regard their mandate
as ensuring that there is complete identity between the systems. This seems unattain-
able in practice as well as being objectionable in theory. The risk of a race to the bot-
tomthat is, a preference by market participants to select the clearinghouse with
the weakest (and cheapest) approach to risk managementmay be exaggerated.
The market participants with the most to lose from weak clearinghouses would,
under both US and EU governance models, remain in a position to prevent such an
outcome.
Based on these conclusions, it might be thought reasonable to assume that a
sound footing exists for an effective mutual recognition system between the USA
and the EU in relation to the regulation of clearinghouses. This article now turns to
examine whether, and if so how, mutual recognition is being achieved.
76 For example, in Germany and France, clearinghouses are treated as credit institutions and can access a
credit line from their central bank. In the UK, clearinghouses do not need to have banking licences so are
not credit institutions, but there is no need to be a bank to apply for central bank liquidity. Accordingly,
clearinghouses have access, though the eligibility conditions for emergency liquidity assistance will be
very tough.
77 Contrast the statement no competition on risk management voiced by regulators in the EU. Cf A
Schonenberger, CCP Interoperability (July 2009) ECB slide presentation <www.ecb.int>. See also
Dermot Turing, Clearing and Settlement in Europe (Bloomsbury, 2012) s 13.19.
M UTU AL RE CO GN IT IO N IN P R ACT ICE

It is evident that complete identity between the regulatory regimes applying to clear-
inghouses and their members may be too distant a goal to be practically attainable.
Both the USA and (in some jurisdictions) the EU have a long history of regulating
clearinghouses, and while standards are similar and based on international frame-
works,78 the long traditions make it equally hard for regulators to abandon existing
local super-equivalent practices or to adopt foreign ones. To achieve effective cross-
market regulation, a solution is needed.
The obvious one is mutual recognition, where each regulator accepts the differ-
ences provided that a core minimum set of standards is in place. Mutual recognition
does not demand identity of regulatory standards, and accepts a degree of uneven-
ness in the playing field. It is therefore appropriate to consider how, in practice, mu-
tual recognition is being addressed in the post-crisis environment, and whether there

are practices or policies that detract from mutual recognition.
EU and US approaches to recognition

EMIR sets a high bar to recognize non-EU clearinghouses as sufficiently robustly
regulated under their home jurisdictions to do business with EU persons.
Recognition is based on a determination that the legal system of a non-EU clearing-
house provides a quality of protection that approximates that provided within
the EU.
EMIR requires that clearinghouses authorised in that third country comply with
legally binding requirements which are equivalent to the requirements laid down in
Title IV of this Regulation, that those [clearinghouses] are subject to effective super-
vision and enforcement in that third country on an ongoing basis and that the legal
framework of that third country provides for an effective equivalent system for the
recognition of [clearinghouses] authorised under third-country legal regimes.79
Immediately, it is evident that equivalence is necessary between the legal and regula-
tory regime of the third country and for the third countrys laws to reciprocate. In
other words, EU regulators demand a two-way street: EU clearinghouses must be
allowed a fair crack at the third countrys clearing market as well as vice-versa.
The equivalence assessment involved in this recognition process is challenging.
Procedurally, the European Commission80 must adopt an implementing act deter-
mining equivalence. In practice, it does so after technical advice by ESMA, which has
supplied extensive comparative tables of laws highlighting differences between the
laws of Europe and those of countries from which clearinghouses applying for recog-
nition are based. As at December 2015, implementing acts according equivalent sta-
tus had been made in relation to Australia, Canada, Hong Kong, Japan, Mexico,
Singapore, South Africa, South Korea, and Switzerlandbut not the USA.81
78 See, eg the CPMI Principles.

80 The European Commission is the body within the government of the EU that has the executive power
and the exclusive power to initiate legislation.
81 Commission Implementing Decisions of 30 October 2014: 2014/752/EU, 2014/753/EU, 2014/754/
EU, and 2014/755/EU, all OJ L311 (31 October 2014).
Clearinghouses from all of these jurisdictions have been recognised as capable of

clearing for EU persons with implementing acts.82
In relation to the USA, ESMA observed that: (i) the US authorities require that
non-US clearinghouses become subject to the jurisdiction of the SEC and the
CFTC, and that this is a departure from the reciprocity regime prescribed under
EMIR; (ii) ESMA would only grant recognition to US clearinghouses that have in
fact adopted policies and procedures which are equivalent to the legally binding re-
quirements for clearinghouses under EMIR in certain specifically identified areas.83
As described earlier in this article, ESMAs analysis noted gaps where the EU stand-
ards appear to be superior to those of the US, but they did not perform the recipro-
cal analysis, which would have revealed inferiorities on the part of the EU system. It
may be concluded that achieving recognition of the USA within Europe presents a
thorny challenge. From the competitive perspective, as long as EU regulators do not

recognize US clearinghouses, EU clearinghouses can also end up with more business.
The approach taken in the USA is difficult to describe as mutual recognition
since it is arguably not a form of recognition at all. A foreign clearinghouse that
wishes to conduct business in the USA will need to satisfy the relevant regulator (in
the case of OTC derivatives, the CFTC) that it qualifies for a licence as a clearing-
house or, in the terminology of the DFA, as a DCO. Insofar as the regulatory stand-
ards imposed by the clearinghouses home country help it comply, that is all well and
good, and the supplementary compliance burden of coming up to the US standard
may be tolerable (assuming of course that the home state law has extraterritorial
reach, so that the clearinghouse will not be excused compliance with its home-coun-
try laws in respect of its activities in the USA). But the CFTC will act as the clearing-
houses supervisor in the USA and will not expect to deny itself the full range of
powers exercisable in relation to a US clearinghouse.
The EU approach is to ensure that the laws of a third country reflect closely the
requirements imposed on EU clearinghouses. The inexactness implicit in the word
equivalent is misleading. Only departure in minor points of detail from the EU le-
gislation appears to be tolerated without remedial top-up by an equivalent countrys
clearinghouses. Once this is established, the non-EU clearinghouse will be assumed
to be supervised safely under a robust legal and regulatory system. There is no need
for EU authorities to interfere and indeed it would be illegal for them to do so. By
contrast, the US approach is to overlay local US regulation onto any home-country
laws and regulation; so much the better if the home-country laws have equivalent re-
quirements to the USAthat will just make it easier to satisfy US requirements. But
the US regulators will actively supervise the foreign entity plying its trade on US soil.
The contrasting systems have unfortunate results. Although the EU system looks
more hands-off, in fact its entry criteria are strict. By contrast, the US model requires
a foreign clearinghouse to top-up to US standards and to ignore the home-country
supervisor. The EU model requires US clearinghouses to top-up to EU standards,
82 ESMA press release, 29 April 2014 http://www.esma.europa.eu/news/ESMA-recognises-third-country-

CCPs. See also, ESMA, Derivatives/EMIR: Legislative Acts http://ec.europa.eu/finance/financial-mar
kets/derivatives/index_en.htm.
83 ESMA Reference 2013/1157.
but then steps out of the regulatory picture altogether. The compliance burden for
international clearinghouses is thus asymmetric and hard to operate. It discourages
EU clearinghouses that attempt to access market participants in the USA. In turn,
US clearinghouses cannot enter the EU market as long as the EU continues to deem
parts of the US regime as being inferior. This intractability, of course, explains why
the clearing obligation had not come into effect even for vanilla derivative products
in Europe as of December 2015.84 This intractability has left international clearing-
houses in a difficult position. Some are seeking to achieve recognition under both re-
gimes.85 Yet, the differences in regime between the EU and the USA, as well as the
challenge of bridging incompatibilities, raise serious difficulties for those seeking dual
recognition. For example, a US clearinghouse seeking to attract EU clients should,
on paper, demand that its clients supply margin on a gross, rather than a net, basis in
order to comply with the stricter standard. Owing to EU rules, its default fund con-

tributions cannot be satisfied by unfunded or more contingent commitments like let-
ters of credit. From the supervisory perspective, the clearinghouse must satisfy both
EU as well as US regulators, where lack of agreement and unfamiliarity on the part
of regulators with another regulatory regime can well create challenges in translating
compliance objectives transnationally. Complying with the stricter standard, meet-
ing duplicative requirements, and paying higher transaction costs might well lead
84 On 6 August 2015 the European Commission adopted a delegated regulation making the clearing of cer-
tain interest rate derivatives mandatory (http://ec.europa.eu/finance/financial-markets/docs/derivatives/
150806-delegated-act_en.pdf). This is the first of several regulations which will introduce mandatory
clearing of OTC derivatives. The regulation will have a staggered start date depending on the detailed
terms of the derivative transactions involved, but compulsory clearing of some transactions will begin six
months after the text of the regulation has been translated and published in the Official Journal of the
European Union. As of December 2015, it remains unclear whether by that time the mutual recognition
question will have been resolved with respect to the United States. Note that US and EU regulators have
variously commented on the lack of agreement on the recognition of international clearinghouses. For ex-
ample, CFTC Chair Massad has extensively commented on differences in the calculation of customer
margin (gross versus net) and differences between the one- and two-day liquidation provisioning require-
ment and the economic impact of these differences. In an important speech in 2015, Chair Massad noted
that US rules (gross customer margin, one-day liquidation) can induce thicker provisioning than EU rules
(net customer margin, two-day liquidation). Chair Massad suggests that customer margin is a more crit-
ical issue in securing financial stability than the clearinghouse default fund, such that a gross margin re-
quirement should secure the clearinghouse more fully. Chair Massad recognized that the one-day
liquidation requirement necessarily means that the amount in the default fund is less than under a two-
day requirement. However, he suggests that customers represent a more important source of risk, with
stricter US rules off-setting any increase in risk created under the one-day versus two-day rule. See,
Remarks of Chairman Timothy G Massad before the European Union Parliament, Committee on
Economics, Brussels, Belgium, 6 May 2015 http://www.cftc.gov/idc/groups/public/@newsroom/docu
ments/speechandtestimony/opamassad-20.pdf. In response, EU regulators suggested that US regulators
might have varying emphases from EU regulators, notably that EU regulators might be more worried
about systemic risk, whereas US regulators have investor protection as a primary focusan opinion that
the United States vigorously contested. For discussion, Philip Stafford, Europe and U.S. Regulators Fail
to Agree on Derivatives Rules Financial Times (15 May 2015). Separately, prominent commentators
such as think tanks have issued calls for an end to the impasse and noted the differences in approach be-
tween the USA and the EU; The Committee on Capital Markets Regulation and the Financial Markets
Law Committee, Comment Paper: Resolving Issues of Legal Uncertainty Relating to the Recognition
and Supervision of Central Counterparties (September 2015); Philip Stafford, Markets Call for U.S. and
E.U. to end Derivatives Dispute Financial Times (2 September 2015).
85 CME Europe (n 10).
clearinghouses to charge clients more for services, potentially reducing business and
lowering revenues.
The gaps left by mutual recognition

Reliance on mutual recognitionor, to be more accurate, the approach to recogni-
tion that has taken its placeas the cure to divergence, fails to address significant
structural differences in the EU and US regulation of clearinghouses. These differ-
ences can impact the relative costs faced by international clearinghouses, depending
on whether they are established in the EU or the USA.
Crisis support
The ability of a clearinghouse to access emergency funds in case of crisis provides an
essential source of support for the clearinghouse and powerful reassurance for the

market as a whole. Where clearinghouses can quickly access lines of credit from the
central bank, or be eligible to receive a bailout from the state, they can conduct their
business on a far surer footing where such support is more contingent. As seen dur-
ing the crisis and discussed in this article, clearinghouses can experience sudden cata-
strophic failures that can be difficult to provision for on an ex ante basis. Defaults by
multiple members, a collapse in the value of collateral or insufficient liquidity can re-
sult in clearinghouses failing to make good on their obligations to clear and settle
trades.86
Importantly, provision for crisis support can impact how fully suppliers of finan-
cial resources to clearinghouses are willing to fund the clearinghouse. If shareholders
and members are likely to see their capital wiped out more quickly, they may be
much less willing to place funds with the clearinghouse. Members, in particular, are
especially vulnerable where the default fund is used up quickly.87 For one, they may
be on the hook in some cases to pay out more to fulfil the clearinghouses unmet ob-
ligations, where clearinghouse rules make such demands. This may place already
stressed financial institutions in further jeopardy.
The EU and the USA appear to diverge in the extent of their access to crisis fund-
ing for clearinghouses. The USA has, under the DFA, significantly restricted the ex-
tent to which the Federal Reserve can create some kind of emergency bailout/
lending measure for a failing clearinghouse. Under the Act, the Federal Reserve is no
longer permitted to craft a bailout for any single failing institution, as it did in the
case of AIG, for example. Rather, if a bailout is desirable from a policy standpoint, it
must be designed to address the distress of a category of financial institution and not
just to deal with the failure of a single firm.88 This suggests that the Fed must be will-
ing to extend taxpayer funding for a group of clearinghouseswith the greater outlay
86 Ben S Bernanke, Clearing and Settlement during the Crash (1990) 3 Rev Fin Stud 133.
87 Of course, there are serious moral hazard concerns in cases where access to credit for clearinghouses is
made too lenient. For discussion, see, Colleen Baker, Coming Catastrophe? The Potential Clearinghouse
and Financial Utility Rescue Plan for OTC Derivatives, Repos, and Other Financial Transactions in
Dodd Franks Title VIII (2010).
88 S 1101(a)(B)(i) DFA. However, Prof Baker suggests that s 806 may have enough flexibility to permit a
wider application, particularly as the word unusual can afford a broad application. For a discussion of the
Federal Reserves expansive role, see, Baker (n 52).
of taxpayer resources this likely entailsin order for a bailout to progress. This
leaves clearinghouses in the precarious position of having to seek access to the Feds
emergency lending through the Feds discount window.89
The DFA allows clearinghouses to be treated more like banks and to apply for
emergency credit from the Feds discount window. But this accommodation is nei-
ther straightforward nor especially streamlined. For one, a troubled clearinghouse
can only obtain emergency credit in unusual or exigent circumstances.90 The inter-
pretation of what constitutes unusual or exigent remains uncertain and may pre-
clude credit from being extended in anticipation of an upcoming probable crisis, but
only in an actual stressed situation. Moreover, the Fed can impose a host of con-
straints on any facility it extends to the clearinghouse, for example, to require that
the clearinghouse exhausts member contributions or avails itself of all other sources
of credit. It remains unclear what kind of collateral or terms the Fed might demand.

Historically, such credit has been expensive and has required firms seeking it to offer
good quality collateral to the Fed as lender of last resort. Whether or not clearing-
houses might be in any condition to comply with such terms is deeply doubtful. The
Feds decision to set-up a credit line also faces much stronger procedural checks and
consultation with the US Treasury than it did during the crisis. With the DFA, the
Treasury will have a say on the viability of any emergency credit facility to a clearing-
house. In short, a US clearinghouse entering a crisis faces significant sources of un-
certainty in determining whether it can access emergency credit from the discount
window or any other Fed crisis facility to deal with fallout.
To be sure, this discussion may be entirely moot. Differences between the EU
and the USA may well be quickly forgotten in an actual crisis. The collapse of a clear-
inghouse invariably entails systemic consequences, meaning that US regulators may
be forced to step in with a bailout no matter the prevailing constraints. But the con-
trasting postures between the EU and the USA suggest that mutual recognition is un-
likely to solve a significant source of uncertainty: should clearinghouses be saved? By
whom? And under what circumstances and conditions?
Allocation of supervisory resources

Differences in crisis financing points to a broader concern about how best to allocate
domestic regulatory and supervisory resources to oversee international clearing-
houses extraterritorially under a mutual recognition regime. Many of the differences
identified in this articlenamely, with respect to default provisions, regulatory cap-
ital, or quality of collateralheighten the supervisory costs faced by regulators. US
regulators, for example, might expect that national bankruptcy laws will not affect a
clearinghouses default provisions. However, as outlined in this article, EMIR cannot
provide a legislative guarantee to this effect, requiring instead that Member States
craft their own solutions to deal with infringements on property rights that may arise
in member default management. Similarly, EU national regulators might expect that
clearinghouses have ready and easy access to crisis funding in case of catastrophe.
89 S 806(b) DFA.
90 S 806(b) DFA.
Despite mutual recognition, any large-scale failure of an international clearinghouse

will necessarily impact both the USA and the EU. It makes a real difference whether
a clearinghouse can access emergency funds, and how well its regulator has provi-
sioned for this possibility. Where regulators might restrict access to emergency credit
or make bailouts contingent, they may well supervise their clearinghouses to prepare
for their eventual failure and wind-down. By contrast, more flexible access to tax-
payer support might point to a greater willingness to work towards the survival of
clearinghouses, even if they might suffer temporary (or longer) periods of non-viabil-
ity. Varying perspectives in this case point to the need for regulators to continue to
fill gaps in oversight despite mutual recognition to assure that international clearing-
houses do not pose risks for domestic counterparts in local markets. Regulators can-
not, then, afford a hands-off approach that leaves oversight exclusively to home-state
supervisors.

It is worth noting that the current state of diverging regulatory regimes also cre-
ates broad, extraterritorial supervisory costs. For one, differences in regulation gener-
ate informational gaps for regulators trying to get a sense of the risks underlying the
global derivatives trade. If the market is fragmented, with some trades clearing
through EU-recognized clearinghouses and others through those overseen by the
USA, informational gaps are inevitable. US regulators will have the best view of activ-
ities flowing through the clearinghouses that they have authorized and that are thus
subject to their supervision. They face high hurdles in securing information on EU-
authorized clearinghouses, even though risks from one jurisdiction may migrate to
the other. This might happen, for example, if complex derivatives trades lacking obvi-
ous jurisdictional hooks are spliced and structured and cleared through clearing-
houses in different jurisdictions using cross-border networks of subsidiaries. These
blind spots can become problematic if traders utilize differences in regulation to en-
gage in opportunistic arbitrage in an effort to lower compliance costs. Regulators
have to work hard to correct these asymmetries. Operationally, this supervisory effort
is made especially costly where diverging regulatory regimes mean that regulators
lack systematic means to request information from peer regulators and from outside
traders and clearinghouses. One advantage of the mutual recognition regime is that it
necessitates interdependence between jurisdictions to share in the costs of monitor-
ing and discipline. Where traders in one regime can create cross-border risks by
clearing their transaction in another jurisdiction, cooperation between regulators be-
comes essential. By contrast, separate regulatory environments, with their own set of
specific stipulations, can segment markets and limit the frequency and persuasive
pull of any demand by one regulator for information from another. As has been
made abundantly clear over the last decade, such lacunae in supervision are ripe for
exploitation by sophisticated and opportunistic traders. This leaves regulators facing
three options: (i) they can leave clearinghouses to privately internalize the costs of
monitoring information deficits, particularly if clearinghouses are connected through
large, international corporate groups; (ii) they may impose higher regulatory require-
ments on clearinghouses under their supervision to account for unknown risks; or
(iii) they can keep current rules and supervisory approaches in place and oblige the
clearinghouse to strengthen its contingency arrangements in case of a total loss of
the default fund (in lieu of a state bailout for unexpected risks). None of these
approaches represents an efficient solution to monitoring risks in the marketplace.
S O ME I MP L I C AT IO NS
This article has shown that the USA and the EU diverge in several key areas in the
regulation of clearinghouses. These differences are understandable and to be ex-
pected. Yet, their significance has grown owing to the tension visible in each jurisdic-
tions failure to recognize the others legal system as equivalent in quality to justify
mutual recognition. This places international clearinghouses and their users in a
bind. Broadly, for a transatlantic trade, market participants face three choices: (i) to
use an international clearinghouse that has succeeded in gaining registration under
both the EU and the US legal regimes; (ii) to instead conclude the trade with a do-
mestic counterparty using a local clearinghouse; or (iii) to act as client in a more ex-

tended chain of back-to-back clearing arrangements.
Various implications attach to these different options. To begin, the decision of
where to clear now appears to be a key part of transactional design. Parties must
now think hard about where to clear the trade. This choice can influence (and is also
influenced by) the identity of the counterparty, the likely cost of the trade and the
regulator(s) that will oversee the deal. The determination of which clearinghouse to
choose, and the arrangements necessary to achieve that outcomelong the preserve
of back-office detailmay now occupy a prime place in deal design. In addition to
higher transaction costs, in the form of fees, requirements to provide margin and
monitoring trades, parties can also face differences in the legal obligations they face.
As discussed in this article, the EU and the USA stipulate varying requirements with
respect to clearing derivatives, like gross customer margin requirements in the USA
versus provision for net customer accounts in the European Union. These variations
generate legal uncertainties for members, customers, and ultimately create costly dis-
incentives that might undermine the attractiveness of the new post-crisis regime as a
viable framework for risk management.
Seeking out a clearinghouse that is registered both in the USA and the EU pre-
sents an alternative to overcome the legal uncertainties that can arise in using two
separate clearinghouses. But, it is not without its drawbacks. Clearinghouses that
must register with both EU and US regulators to clear transatlantic trades face dual
compliance costs to meet the varying stipulations of US and EU regulations. They
are also likely to see oversight by a multiplicity of regulators from the EU, the USA
as well as by national regulators from EU Member States. These costs may be passed
on to users and members. To the extent that higher costs burden customers that use
clearinghouses, the trade-off between using clearinghouses and remaining in the opa-
que OTC market becomes more compellingan outcome undesirable from a policy
standpoint.
To manage costs and to deal with the legal uncertainties, traders might seek to
conclude deals with local counterparties and to utilize the services of a domestic
clearinghouse. This option brings the advantage of legal certaintyand potentially,
lower transaction costs. However, it also brings significant problems. For a start, par-
ties may face a smaller market made up of traders either drawn from their own
jurisdiction or who are facing similar difficulties to themselves. But more competitive
deals may be found elsewhere. For the clearinghouse, capturing only domestic busi-
ness also presents risks. A smaller volume of attracted clearing may upset the busi-
ness model, reducing fees and potentially encouraging its management team to
consider a race to the bottom. From a risk management perspective, the outcome
of a smaller, more concentrated pool of members, places greater strain on default
management where survivors have to pick up the closed-out positions of defaulters.
The third possibility, to extend the clearing chain, using an eligible clearinghouse
that is accessed via a member who may be affiliated or unrelated to the trader, im-
poses an additional layer of risk and cost. Being a client of a clearing member is not a
guarantee of a counterparty-risk-free transaction. To start with, the client will be
exposed to the credit risk of its chosen clearing member. Also, there may be exposure
to the other clients of the clearing member. Finally, the cost equation changes, as the

margining arrangements of the new clearing member do not necessarily match those
of a clearinghouse, layers of onerous documentation may be added, different regula-
tory capital implications of being exposed to a new clearinghouse member will apply
and so on.
Regulators might also consider a broader set of problems emerging from the di-
vergences that exist in the regulation of clearinghousesand the failure to overcome
differences between national regimes. First, varying legal regimes for clearing similar
products invite traders to seek out the cheapest way to conclude their trade. This ar-
bitrage means that parties can select the clearinghouse and jurisdiction that will de-
liver settlement at the lowest possible costdemanding lower fees, less stringent
margin or reporting requirements, and laxer monitoring of trades. Earlier, we sug-
gested that clearinghouse members might not necessarily be willing to entertain a
race to the bottom, given that they have a lot to lose in the process. However, even
with skin in the game, traders and members acquire the ability to engage in strategic
regulatory arbitrage. Parties gain the ability to select favourable regulatory solutions,
where these might reduce the transaction costs attaching to trades, particularly those
that might be riskier and more expensive to clear. The possibility of arbitrageone
that can readily be exploited by informed tradersheightens the accumulation of
risk into the financial system. Regulators can find themselves on the back foot given
that they face nimble, strategic traders with superior information on their deals. This
places considerable burden on regulators to coordinate in the collection of informa-
tion, monitoring of traders, and in countering inappropriate opportunistic behaviour.
Secondly, the hardening of differences in regulation between jurisdictions can
make it less likely that regulators coordinate and cooperate in the regulation of clear-
inghouses. Importantly, national systems are ultimately responsible for the financial
health and viability of clearinghousesdeeply significant and systematically
embedded institutions in the functioning of an economy. This can entail providing
emergency credit and bailouts to support distressed operations in the event of failure.
Equally, regulators can benefit where their national clearinghouses perform profitably
as choice venues for clearing a variety of trade types in international markets. These
policy goals can, however, be in tension. National regulators might benefit by cali-
brating rules and enforcement to generate higher volume and brisker business for
their clearinghouses. This motivation can be problematic where it leads regulators to
nudge their clearinghouses to take on riskier trades, or to afford them a laxer super-
visory environment. Where regulators might support local champions, they may be
more reluctant to share information about clearinghouses and the trades that pass
through them with other regulators, particularly if they do not have to internalize the
full cost of clearinghouse failure. In other words, if another countrys regulator is
more likely to supply the emergency credit support, it might dis-incentivize home
regulators from taking a hard-line approach to profitable risk-taking by clearing-
houses and their members. Divisions in regulation between jurisdictions can give rise
to competition between national regulatorsmuch to the detriment of cooperation
in the oversight of complex, global markets.
CONCLUSIONS
This article explores the international aspects of regulation of clearing of OTC de-

rivatives. While an approximate consensus as to how clearing should be regulated
exists, it is noted that the consensus is creaky, and that in a number of areas there are
differencessome major differencesbetween the approaches of US and EU regu-
lators. These differences are to be found both in relation to risk management issues
that affect clearinghouses and also in relation to factors that, while not directly con-
stituting part of the canon of clearinghouse regulation, affect its practical operation.
While no exact uniformity exists for regulation, it is important to understand the
extent to which market participants may exercise a choice not to clear or to clear at a
clearinghouse which is in a different market from their home country. With OTC de-
rivatives, there is no obvious geographical anchor, which gives plenty of scope for ar-
bitrage for both clearinghouses and market participants; but it also gives scope for
regulators to apply long-arm interpretations of their own jurisdiction.
The choices made by market participants may have important consequences,
which affect the ability to deliver the G-20s policy objective effectively. Where a
choice as to whether to clear a transaction still exists, the costs and benefits of clearing
will be weighed by the market participants. Too much cost, and too little benefit, will
result in the transaction remaining uncleared. Even if clearing is mandated, there
may still be a choice of venue for clearing; and again a costbenefit assessment is
likely to happen. Participants in the clearing marketplace may be free from any direct
legal or regulatory discrimination but may still find that the choice of doing business
at home or abroad is not free from legal or regulatory factors. Decisions may be influ-
enced by considerations of cost, risk, governance, operational simplicity, all of which
may differ by comparison with home-jurisdiction standards. These differences mat-
ter. They can lead market participants to select cheaper, riskier, or less suitable places
at which to clear.
Where clearinghouses compete relatively freely for business, there is a playoff be-
tween factors that may attract that business and those that may repel it. This playoff
is complex. On the one hand, lower costs (including lower margin rates and lower
default fund commitments, as well as lower fees) may attract new business. On the
other hand, higher margin and default fund obligations may imply a more prudent
approach to risk management and may paradoxically be an attractive factor.91 A race
91 Turing (n 76) especially s 13.19.

to the bottom might be self-braking for this reason, provided that governance stand-
ards in clearinghouses continue to allow the larger members a say in risk manage-
ment. A clearinghouse that has lost the support of the larger membersthe core
investment banks specialized in dealing and clearing of OTC derivatives transac-
tionsis unlikely to thrive in business.
Essentially, the basic rules for risk management of clearinghouses have been set-
tled. Nobody is gifted with the ability to say that a particular default-fund model is
better than another or that one margin algorithm is superior to all others.
Competition and upgrading to meet changed market conditions are to be encour-
aged by regulators, and overzealous standardization is not conducive to anything
other than stagnation.
A race to the bottom may thus not be the outcome of unevenness in the regula-
tory playing field; but nonetheless, where differences exist, the market will expect to

exercise a choice. Legal and regulatory rules that apply to questions other than clear-
inghouse risk management may influence that choice and discourage a fully effective
international marketplace. Where the vital questions of risk management do not
clearly point the way, there is a danger that secondary factors assume undue signifi-
cance. Differences between the US and EU approaches cannot safely be disregarded.
We do not say that under-regulation exists in one or other place, but we expect that
market participants will weigh the factors which are important to them and make
their choice accordingly. Once the problem of mutual USEU recognition is
resolved, and compulsory clearing takes effect in the EU, this question will become
even more relevant. Regulators should carefully consider the need to retain historical
rules that are super-equivalent to the core international norms.
Weak clearinghouses may be encouraged and market participants may try to re-
structure their transactions to avoid the clearing obligation. Mutual recognition will
remain an aspiration unless a consensus is reached on which regulator should have
jurisdiction over what aspects of clearing, and in respect of which types of transaction
and counterparty. Regulators should prioritize seeking a solution in this area above
the many interesting questions relating to risk management equivalence.

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Journal of Financial Regulation, 2016, 2, 2155

The Extraterritorial Regulation of Clearinghouses

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2 Atlantic Council Divergence Report, 2931 http://www.atlanticcouncil.org/images/publications/Danger_

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Risk Committee requirements;

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derivatives regulation, where clearinghouses are subject to acceptable national rules,

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This article proceeds as follows. The Significance of Clearinghouses in Financial

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The costs of managing clearinghouse risks

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responsible for clearing most US-traded equities operates on a member-owned

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contribution to safe, well-functioning derivatives trading, international regulators

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31 The G-20 Pittsburgh Summit (n 1).

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The creaky consensus: the US approach

aspects of a clearinghouses operation and organization, such as safety and sound-

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40 http://www.cftc.gov/IndustryOversight/ClearingOrganizations/index.htm; Derivatives Clearing Organizations

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to systemic safety than those governing the clearinghouses member-supplied default

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Financial resources on default

45 Remarks by Chairman Massad (n 84).

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Financial resources on default

59 ESMA Equivalence Assessment (n 6).

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65 Ibid article 45(1).

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71 ESMA Equivalence Assessment (n 6) Annex III, 122.

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74 EMIR, article 16(1).

support to clearinghouses.76 However, it does not necessarily empower them either.

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M UTU AL RE CO GN IT IO N IN P R ACT ICE

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EU and US approaches to recognition

78 See, eg the CPMI Principles.

Clearinghouses from all of these jurisdictions have been recognised as capable of

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82 ESMA press release, 29 April 2014 http://www.esma.europa.eu/news/ESMA-recognises-third-country-

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The gaps left by mutual recognition

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Allocation of supervisory resources

Despite mutual recognition, any large-scale failure of an international clearinghouse

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