US regulators, preoccupied with modifying the decade-old, hastily put together Dodd-Frank regulatory regime, have let their guard down, potentially leaving the European Union’s (EU’s) fast-tracked regulatory regime to dominate US financial institutions behavior.
Two pieces of EU regulation, EMIR (European Markets and Infrastructure Regulation) and MiFID (Markets in Financial Instruments Directive), scheduled for final implementation on Jan. 3, 2018, are forcing US-based financial institutions to accommodate more onerous regulations if they are to participate in EU markets and provide services to EU clients.
EMIR forces US companies that wish to do business with European counterparties to follow their rules on derivatives for trading venues, central counterparties and trade repositories. MiFID sets out the rules for trading, market research, investment firms and sets data standards for trade and market data reporting.
US capital and derivatives markets had for long been the gold standard, thought to be the fairest, most liquid and best managed. Regulation and oversight of US markets and their financial institutions, up to the financial crisis, was thought to be first class.
Now, European rules are setting a new gold standard, more comprehensive than US ones, reversing the decades-long dominance of US markets and their financial institutions having the best-in-class risk and regulatory regimes.
Another determinant of EU’s rising prominence is their adaption of the Basel Committee on Banking Supervision’s (BCBS’s) capital and risk regimes, a global framework for implementation by sovereign regulators, that is being adhered to closely in the EU but not so in the US.
To understand the potential of the US to evolve to an EU-centric financial system, we need to understand some of the changes to practices of U.S. financial institutions fostered by EU rules:
- OTC derivatives trades forwarded to US regulators by a single counterparty are accepted as matched (completed). Those same transactions in the EU must be sent by both counterparties to the trade, thereafter to be matched to confirm completion.
- Foreign Exchange forward contracts need to be margined for the first time.
- Implementation of new risk models and historical data is to replace earlier risk models and simulations used by US banks, reflecting EU’s lending finance orientation vs. the US’s capital market financing culture.
- All trades placed by US firms with EU financial institutions must register their identity and parental owner.
- No new issues or contracts will be registered on an EU trading venue without obtaining newly constructed product identifiers and legal entity identifiers.
- No trades will be accepted unless firms provide personal identification information of traders initiating a financial transaction.