London Stock Exchange to lose spreads on CCP interest

On Thursday Sept 27 2012, ESMA published its technical standards on the Regulation on OTC derivatives, central counterparties and trade repositories (EMIR). Among other things, this document spells out specifics of how CCPs need to manage their risk waterfalls, margin and investments from free cash. The London Stock Exchange Group reported that the new rules are expected to have a heavy impact, as 14% of current earnings are made up of money earned from spreads between the interest rate on cash deposits in the Italian market and repo rates. This is some real money for the LSE.

According to the LSE’s press release on the matter, the new standards will require:

“· the capital of any European-based CCP to be at least equal to the sum of (i) its gross operational expenses for winding-down or restructuring over an appropriate time span, subject to a floor of six months and (ii) the capital required to cover overall operational and legal risks, credit, counterparty credit and market risks stemming from certain activities and business risk;

· any European CCP to notify its regulator if it holds less than 110% of
its capital requirement; and

· any European CCP to hold an additional amount of its own resources equal to 25% of its capital requirement, which it must use before using the default fund contribution of non-defaulting clearing members to cover losses arising from the default of a clearing member.”

Here’s the kicker: “ESMA has proposed that 95% of such deposits must be collateralised with debt instruments meeting certain conditions regarding, among other things, liquidity and credit and market risk.”

The problem for LSE is that Monte Titoli’s investments on deposits don’t necessary meet the definition spelled out by ESMA, and that the CCP has been taking advantage of spreads in the cash deposit market vs. repo rates to earn outsized income. While the LSE release recognizes that this income has been unusual, a loss of the opportunity is still a loss.

LCH.Clearnet takes a hit here too, which is another tough break for soon-to-be owner LSE. LCH.Clearnet issued a press release on Friday that “if the new recommendations are adopted in the current form, LCH.Clearnet Group currently estimates that it will increase its regulatory capital by approximately €300-375 million which it intends to have in place during the first half of 2013 in order to comply with the new regulations in advance of applicable regulatory deadlines.” We’re going to see CCPs in Europe start publishing capital ratios to prove their strength even when they haven’t been before (LCH.Clearnet says it is at 25.2%).

Here is a link to the ESMA technical standards.

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