House Agriculture Committee Chair K. Michael Conaway (R-TX) and Ranking Member Collin Peterson (D-MN) expressed concern with the European Commission's recent decision to delay implementation of rules on margin for uncleared swaps. In a letter to federal banking regulators and the CFTC, the Congressmen urged them to work with the European Commission (the "EC") to adhere to the agreed timetable or to coordinate a new global implementation timeline.
The Congressmen stated that the EC's decision to delay the rules is "surprising and unexpected," and "undermines" the international coordination commitments of the new derivatives market rules that would "prevent a needless financial unraveling across global markets." They emphasized that margining all uncleared swaps "represents a foundational change" to the operation of the global derivatives markets, and will "help ensure that risk is appropriately managed among market participants."
Commentary
Given that it is extremely unlikely that the European regulators will change their minds and determine to reaccelerate the imposition of margin requirements (especially now with the additional complication of Brexit), the Congressmen are, in effect, telling the U.S. regulators to slow down to the European schedule. Hopefully, these regulators will accede to that request, as the alternative would put U.S. firms at a considerable disadvantage.
The need for international coordination highlights some of the major flaws involved in mandatory clearing with margin set by government regulators. First, taking market forces out of the equation, and leaving the establishment of margin levels to governments, assures that decision-making will be absurdly slow. Second, government regulators setting margins will be driven more by political considerations than by economic considerations. Third, margin levels may be set either materially too low, thereby increasing risk, or materially too high, also increasing risk because (i) hedging transactions are discouraged and (ii) excessive demands for collateral by the clearing agencies will drain liquidity.
A lot can be said for bilateral margining, a competing paradigm where individual firms make the credit/economic decisions. In that paradigm, the regulators could manage risk by establishing capital requirements, which could be set at a higher level for firms that collect insufficient margin. Instead of the manageable chaos of bilateral margining where hundreds of decision-makers could flexibly and quickly change their credit policies at any time, we presently have the "rationality" of clearing houses where margin is to be set by a single coordinated government that may take years to arrive at any "solution," and incapable of making adjustments on the fly.
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