A successful integration of EU capital markets hinges upon three words: liquidity, liquidity and liquidity. That is the spirit of an 80-page document that the British Bankers’ Association (BBA) has sent to the European Commission as part of a major review of the continent’s financial rules.
Published on 2 February, the BBA paper was drawn up in response to a top-level call for evidence issued by financial services commissioner Lord Hill. Material gathered in the exercise will inform Hill’s Regulatory Fitness and Performance programme (REFIT), an overview of finance directives that was set up to highlight potential inefficiencies, such as cases where rules overlap or clash – thereby paving the way for full-scale Capital Markets Union (CMU).
With Hill’s predecessor Michel Barnier driving through more than 40 finance laws in the wake of the global financial crisis, REFIT also aims to determine whether certain regulations may have chilling effects on the financial markets.
Devoting eight pages of its paper to the topic of liquidity, the BBA zeroes in on the European Markets Infrastructure Regulation (EMIR), a law that is still being rolled out, three and a half years after its initial measures came into force. Overseen by the European Securities and Markets Authority (ESMA), the package consists of numerous directives, plus an ESMA ‘Q&A’ document that offers guidelines for interpretation.
The BBA’s concerns focus upon EMIR’s approach to central counterparty clearing houses (CCPs) and central securities depositories (CSDs) – particularly in relation to triparty collateral-management providers.
In the BBA’s view, triparty providers enable “highly efficient” transfers of securities between collateral givers and takers, as long as three conditions hold true:
The BBA pointed out that key parts of both EMIR and the ESMA Q&A “either prohibit, or severely impede” a CCP from opening a securities account at a triparty provider that is not a CSD. “The consequence,” it wrote, “is that in order to use a triparty provider, the collateral giver has to both open up an account at a triparty provider that is a CSD, and transfer securities to that account. For many categories of market participant, these two requirements may be difficult to achieve.”
It added: “Many market participants are not able to open accounts at CSDs, and so it may not be possible to meet Condition 1; Condition 3 may also be difficult to achieve, given that many market participants hold, and use, major collateral positions at triparty providers that are not CSDs.”
In their current form, the BBA wrote, the relevant EMIR and ESMA clauses are having “an impact on market liquidity”, which is likely to increase “as more financial-market activity is cleared by CCPs”. That outcome, it stressed, “is perverse: regulatory measures to increase the use of CCPs will lead to broader categories of market participant needing to provide collateral to CCPs; [however,] regulatory measures should facilitate the provision of collateral to CCPs.”
The BBA also criticised transparency requirements in the Markets in Financial Instruments Directive (MiFID), arguing that they incorrectly classify a number of illiquid instruments as liquid. “Subjecting illiquid product classes to transparency requirements,” the BBA wrote, “will potentially reduce the availability of liquidity in those products. Market makers will become reluctant to provide quotes on less-liquid products, primarily because other market participants may trade against them, and positions cannot be rapidly de-risked.
“The end result will be higher costs for end users and less liquid markets. Quote-driven and growth markets will be significantly impacted. Institutional investors will be very unlikely to invest in growth markets, as they will not buy illiquid products that cannot easily be sold on.”
Further to the BBA response, Lord Hill has also received feedback from a number of blue-chip corporations. In a joint letter seen by the Financial Times, Ford, Volvo, Time Warner, IBM, Vodafone and others took aim at Europe’s derivatives rules, writing: “We have serious concerns that corporates using derivatives for hedging purposes today are unnecessarily and disproportionately burdened by [onerous] requirements … These corporates do not pose systemic risk and did not cause the financial crisis.”
For the BBA’s part, its chief executive Anthony Browne said that Hill’s review is the “first step to ensuring that European laws governing financial services work efficiently” for both consumers and industry. He added: “There have been huge reforms put in place since the crisis. The industry is keen to assist the Commission in its efforts to identify whether some of these regulations are unintendedly stifling competition, hampering diversity and, ultimately, dampening economic growth.”