Newedge Comment Letter on Derivatives and Market Infrastructures

8/8/2019 Newedge Comment Letter on Derivatives and Market Infrastructures

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The Pulse of Finance _II

BY E-MAIL AND OVERNIGHT MAIL

July 9, 2010

European Commission

Directorate General Internal Market and Services

Financial Services Policy and Financial MarketsFinancial Markets Infrastructure

B-I049 Brussels Belgium

[email protected]

Re: Newedge Group/Public Consultation on Derivatives and Market Infrastructures

Newedge appreciates this opportunity to comment on the European Commission's

("EC") Public Consultation on Derivatives and Market Infrastructures ("Consultation"). 1

Newedge has been quite active over the years, both in Europe and elsewhere, in working

with regulators to develop rules and regulations designed to strengthen our financial

markets. In Europe, Newedge has provided input to, among others, the Committee on

European Securities Regulation ("CESR") and the International Organization of

Securities Commissions ("IOSCO") in connection with the formulation of various rules

and initiatives. Given our broad experience across asset classes - including securities,

futures and OTC derivatives - we feel we are strongly positioned to provide such input

and welcome the opportunity to do so.

We applaud the EC for examining ways to increase the transparency and liquidity of,

provide for fair and open access to, and decrease the systemic risks associated with the

execution and clearing of OTC derivatives. We believe the need for OTC derivative

reform - throughout the world - is of paramount importance given the harmful role some

OTC derivative transactions played during the recent financial crises. As noted by the

EC, while OTC derivatives can and do playa "useful role" in the economy:

I As the EC is aware, the Consultation supplements two previously published documents relating to OTC

derivatives reform; namely, the "Leaders' Statement," issued in connection with the G-20 summit held in

September 2009 ("Leaders' Statement"), and the October 20,2009 EC publication entitled "Ensuring

Efficient, Safe and Sound Derivatives Markets: Future Policy Actions ("Future Policy Actions")

(collectively, all three documents referred to as "OTC Reform Documents").

Newedge USA, LLC

630 Fifth flvenueTEL 6465579000uite 500 Alubsidiary of Newedge Group

NewYork, NY 10111 FAX 646 557 8480 Member SIPC and FINRA www,newedgegroup.(om

mailto:[email protected]

mailto:[email protected]



they also contributed to the financial turmoil [of the recent economic crises] by

allowing leverage to increase and by interconnecting market participants, a fact

which went unnoticed because of the lack of market transparency, resulting from

the predominant over-the-counter (OTC) market structure.

See Future Policy Actions at 2.

That being said, Newedge would like to take this opportunity to reiterate what it believes

to be some of the most important elements of OTC derivative refonn. Specifically, webelieve that:

1. OTC derivative transactions should, to the maximum extent possible, be cleared

through centralized clearing platfonns ("CCP") and, to the extent they are not, be

reported to centralized repositories to ensure adequate transparency.

2. CCP must be open to buy-side participation through qualified brokers, and not

solely available to dealers.

3. CCPs must have fair and transparent governance structures that, among other

things, prohibit the issuance of material rules through self-certification (i.e.,without the substantive review of a governing authority).

4. CCPs must have clear and fair default resolution mechanisms that, among other

things, prevent them from holding clearing members not participating in the

clearance of certain product types responsible for losses attributable to the

liquidation of positions in such product types by other defaulting members.

BACKGROUND

Newedge, which refers to Newedge Group SA, and all of its global subsidiaries, is one of

the world's largest brokerage organizations. Newedge offers its customers clearing and

execution facilities across multiple asset classes including futures, securities (fixed

income and equities), options, FX and various OTC instruments. 2 Newedge maintains

offices in over 15 countries, and is a member of over 80 exchanges worldwide. Newedge

estimates that its customers -- who are principally institutional -- executed and clearedapproximately 2.9 billion exchange-traded contracts in 2009. As of December 31, 2009,Newedge had an estimated global market share in listed derivatives of 12.1% (clearing)

and ll.l % (execution), and over $54.8 billion of client assets on deposit. Newedge was

ranked among the top brokers on most European exchanges for both clearing and

execution volume as of the end of 2009. Newedge's primary function is that of a broker;i.e., to execute and clear customer transactions across multiple asset classes on an agencybasis. Newedge conducts very little proprietary trading, and then generally only as ahedge or otherwise in connection with the facilitation of customer orders.

2 "Newedge" refers to Newedge Group, a 50%-50% joint venture between Credit Agricole Corporate andInvestment Bank (formerly Calyon) and Societe Generale, headquartered in Paris, France, and all of its

worldwide branches, subsidiaries and other units.

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Newedge is also very active in Asia, Europe and the US with respect to the execution and

clearance ofOTC derivatives, including financial, commodity and FX based swaps,

options and forwards. Newedge executes OTC derivatives on both an agency and

principal basis, but always acts as a broker in such transactions, and never as a dealer.

Newedge has significant experience with respect to the centralized clearing ofOTCderivatives (including in Europe) as well. For example, Newedge has been a member of

CME ClearPort - which provides for the centralized clearing of OTC executed energy,

metals, agricultural and FX swaps (pending) - since ClearPort's formation in 2002.

Indeed, Newedge has been pro-actively involved with the industry for a number of years

in promoting the establishment of fair and transparent CCPs for OTC derivative

transactions. Not surprisingly, Newedge is a member of (a) most clearinghouses globally

that provide such clearing services - including ICE Clear, the International Derivatives

Clearinghouse and SGX AsiaClear - as well as (b) the Swaps and Derivatives Market

Association, the US Futures Industry Association, and the International Swaps and

Derivatives Association.

DISCUSSION

Newedge believes that: clearing OTC derivative transactions through CCPs will increase

transparency and liquidity, lower transaction costs and reduce the systemic risks

associated with such transactions; allowing non-dealers to become clearing members

increases market transparency and liquidity which, in turn, narrows spreads and lowers

transaction costs; establishing a fair and transparent governance structure creates a "level

playing field" for market participants and thereby encourages their continued

involvement in a CCP, and; having strong default mechanisms increases member

confidence which, again, encourages their continued involvement. These results are

entirely consistent with the goals, mandates and objectives of the CESR, rosco and the

Markets in Financial Instruments Directive ("MiFID") relating to financial markets

generally.3

We believe the proposals contained in the OTC Reform Documents are generally

consistent with these principles, and in some cases support them explicitly. However,

certain of the more specific elements ofOTC derivative reform we note above are not

part of the proposed reform package, such as a prohibition against material rule self

certification, a requirement that CCPs be open to qualifying brokers, and a prohibition

against CCPs holding clearing members not participating in the clearance of certain

product types responsible for losses attributable to the liquidation of positions in such

product types by other defaulting members. Given the importance of these requirements

3 See Charter of the CESR. p. I (goals include seeking "the growth of efficient, competitive and sound

financial markets" and "protecting investors, ensuring the integrity and transparency of markets and

securing the proper functioning of the financial system"); MiFID Objectives (goals include "[o]ffering

investors a high level of protection," [e]nsuring a high quality of execution," "[p]roviding a coherent and

risk-sensitive framework for regulating order execution," "[e]nhancing transparency on liquidity," and

"[u]pholding the integrity and overall efficiency of the financial system"), and; Objectives and Principles of

Securities Regulation, OICU-IOSCO (goals include "[t]he protection of investors," [e]nsuring that markets

are fair, efficient and transparent," and "[t]he reduction of systemic risk").

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to the proper functioning of the derivatives market, we recommend that they be mandated

specifically.

I. Buy-Side Participation Through Qualifying Brokers

Section 1(3) of the Consultation states:

In order to give full effect to the clearing obligation, market participants

must have full access to a CCP according to a clearly defined legal principle

of access: A CCP that has been authorized to clear eligible derivative contracts

would have the obligation to accept clearing such contracts on a non

discriminatory basis, regardless of the venue of execution.

Section II(5)(a) of the Consultation states:

A CCP should establish the categories of admissible clearing members and the

admission criteria. These criteria should be non-discriminatory, transparent andobjective so as to ensure fair and open access to the CCP Criteria that

restrict access should only be permitted to the extent that their objective is to

control the risk for the CCP.

Thus, the aTC Reform Documents support, in our view, the concept that CCPs should be

made available to different types of market participants.4

However, in order to remove

any potential ambiguity as to the types of entities that may qualify as clearing members,

we recommend that the EC state explicitly that qualifying brokers be eligible for

admission to CCPs. By ensuring that qualifying brokers may become clearing members

and register eligible aTC transactions with CCPs, the EC will create what we call "open"

CCPs which, in our experience, have led to increased transparency and liquidity and

narrowed spreads in the aTC derivatives market.s

We also note in this regard that a CCP's qualifying requirements for brokers and other

applicants - i.e., its "admission criteria" - must be fair, objective and based on significant

commercial, risk-related or other legitimate needs (and be subject to review by the

relevant governing authority). More specifically, qualification requirements resulting in

the exclusion of non-dealers without a material basis must be disallowed.

4 See also Section 3.1(3) of Future Policy Actions (EC to propose legislation setting forth "[I]egal

protection to collateral and positions provided by clearing members' customers, so as to encourage a wide

range of market participants to use central clearing").

5 Increasing the number and type of clearing members in a CCP - in our view and that of the EC itself-

also reduces the systemic risk associated with OTC derivatives by decreasing concentration risk. See EC

Derivative Markets - Frequently Asked Questions ("an additional factor that needs to be taken into account

[in assessing the risks ofOTC derivatives] is the extreme concentration of some market segments, which

entails severe implications in case one ofthe players defaults").

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2. Fair and Transparent Governance

The aTC Reform Documents also generally require that CCPs have fair and transparent

governance structures. See, ~ . Section 1I(l), (2) and (3) of the Consultation. In

particular, we note favorably the requirements that CCPs: create risk committees

"composed of representatives of its clearing members and independent administrators;"notify their governing authorities in cases where they do not abide by their risk

committees' decisions, and; allow the clients of clearing members to participate in risk

committees or establish an appropriate consultation mechanism that ensures that their

interests are adequately represented.

The aTC Reform Documents do not, however, address the manner in which CCPs will

issue new rules and, more specifically, whether CCPs will be permitted to issue rules

through "self-certification." As noted, we feel strongly that rule self-certification should

not be permitted in connection with material rules. Self-certification would enable CCPs

to issue rules that materially impact the rights and obligations of members without

allowing such members, or the governing authorities, the ability to review and commenton such rules and thereby ensure that the interests of all market participants - and the

market itself - are adequately protected. In our view, CCPs should be required to obtain

approval on new material rules from their internal risk committees and governing

authorities prior to implementing them. Only then will the rights of all clearing members

be fully-protected.6 At a minimum "material rules" should be rules that potentially

impact a member's capital or deal with default situations.

We also understand in this regard that the CESR will be replaced by the European

Securities Markets Authority ("ESMA") once the Member States and the European

Parliament have agreed on the parameters for the new European Supervisory Authorities.

Consequently, we believe it is important that the role ofESMA in monitoring and

regulating CCPs - and in particular, its views on CCP rule issuance and self-certification

- be clarified. In our view, ESMA should take an active role in monitoring individual

CCPs and, for the reasons discussed above, prohibit them from issuing rules materially

affecting the rights and obligations of member firms through self-certification.

Finally, with respect to governance generally, we question why the EC states that the

input of risk committees "would not be required .. ... in emergency situations." See

Section II(2)(c) of the Consultation. In our view, the input of risk committees would

perhaps be most critical during times of crises or emergency. We also recommend that

the role ofESMA in CCP emergencies be clarified. For example, should ESMA have the

authority to intervene in CCP crises and mandate that they take certain actions? And, if

so, what are the types of crises in which it may intervene and what types of actions may it

6 We note in this regard that Newedge and MF Global recently sent a joint letter to the US Commodity

Futures Trading Commission and the Chicago Mercantile Exchange ("CME") objecting to CME's

establishment of a new rule - issued via self-certification - holding all clearing members responsible for

the liabilities of a defaulting member involved in the clearing of credit default swaps ("CDS"), including

members who do not participate in CDS clearing. We believe the issuance of this rule is an example of the

potential inequity that can result from self-certification.

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believe that any product that is cleared through a CCP should also be executed on a

centralized platform and, to further encourage centralized clearing, capital rules should

be adopted that reward intermediaries for holding centrally cleared products and penalize

them for holding non-centrally cleared ones.

* * *Newedge believes the Reform Documents are a very positive step, and we commend the

EC for taking this initiative. We also hope the EC will consider the suggestions and

comments stated herein, and note that we would be pleased to discuss them further upon

your request.

Finally, we believe it is important that the EC andESMA harmonize its rules with those

of other regulato around the world, and particularly with thoseof the Securities and

Exchange Co issio d the CFTC in the US, to avoid an environment promoting

regulatory ar itrage bya C dealers.

us to provide our views on the proposed rules.

. -" I. " ~ " / a a l anaging Director and Group General Counsel

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Newedge Comment Letter on Derivatives and Market Infrastructures

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