Quick Takes: The European active account requirements revisited
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Ali Curi: Hi everyone, and welcome to ION Markets Quick Takes, I'm Ali Curi. And every week, along with my guests, Chris Barnes and Mark Bell, we take a quick dive into the headlines on the Clarus blog. Let's get started. 

Hi Chris. Hi Mark. 

Chris Barnes: Hey Ali. How you doing?

Mark Bell: Hey Ali. 

Ali Curi: Hello gentlemen. Welcome back to Quick Takes.

Chris, let's start with you. What's your Quick Take for this week? Which headline from the Clarus FT blog would you like to discuss? 

Chris Barnes: Well, Ali, this week is a sad week. This is the podcast I never wanted to have to record. This is Chris Barnes officially admitting I f***** up. Doesn't happen very often. I think I've done it once in 10 years of blogs.

The previous time, I missed a footnote. This time, I missed a word. And so, the latest blog I've published, I'm a massive West Wing fan, I love Jed Bartlet and Jed Bartlet has this brilliant scene in the Oval Office where he's like, "You just have to stand there in your wrongness and be wrong." So we're just going to have a moment where I stand here in my wrongness and I'm being wrong.

So what was I wrong about? I missed a word. So the blog in question is the "European Active Account Requirement." It's a really, really hot topic. Clarus on the blog have been following it for like, it feels like eight years. This is all as a consequence of Brexit, really, so I would like to blame Brexit as well for this.

But what happened at the end of last year is that ESMA published the actual requirements of how people are expected to satisfy holding an active account for clearing of interest rate swaps in Europe. This is only a proposal. At this stage, a consultation. I read it at the end of last year, really wanted to blog on it.

I've been meaning to do it, I've been meaning to do it. And then finally published it in the very beginning of February. And I was really surprised because there's been a lot of articles written about the proposal, but nobody's actually taken the step of running the numbers. So I thought it was just a really, really glaringly obvious thing to do in that we've got a proposal here, it states how many trades you're meant to do. It even states the size of trades that you're meant to do. And yet I hadn't seen any headlines that says ESMA proposes trading 1. 3 trillion euros of interest rate swaps in Europe. I just thought it was such an obvious Clarus blog. I was kind of excited about it.

And so I ran through the technical details and it is quite in-depth, right? ESMA have defined 12 subcategories of swaps that runs across different maturities and different sizes. And it said for the largest dealers, you've got to trade five trades in the subcategories. So when I multiplied it up, I thought you were looking at a total for a dealer of 720 trades.

I thought you had 12 subcategories. You've got to trade them every month and you've got to do five in each of the categories. You do the maths, you read the blog. I thought that big dealers were going to have to do 720 trades. 720 trades of different maturities of different sizes across a year.

But, and this is quite gratifying, I published that blog and EUREX called me and went, "Chris, we really value you covering this. We really value the fact that you keep it on people's radars. But are you sure that you've got it right?" And immediately, when you're a man who's sat in an office writing a blog that takes about four or five hours to research, write, publish, check, etc.

And you've got a global corporation like EUREX going, "Are you sure you're right?' I was like, "No, I'm really not sure I'm right!" I try and make sense of these regulations, but it's complicated. EUREX were like, "Yeah, well, a little bit of sympathy with you. We have a team of lawyers and even they're not sure whether they're right."

And so they very, very kindly, they were so, so polite. They said, look, "We think you've missed a word." And the word was "relevant." And so, yeah, it was a really, really relevant word because actually what ESMA say is that you don't have to trade in all of the 12 subcategories. You only have to trade in the five most relevant.

Now, even on that call, I was scratching my head, going, why would a regulator bother to define 12 subcategories, but then leave it to market participants to have to measure everything and make sure that they're trading in Europe in their five biggest. Well, it's still kind of leaves a bad taste in my mouth.

That might be because I got it wrong, but the outcome of that is that we're not talking about 720 trades. We're talking about 300 trades a year. This is still really significant. If you think about having 25 dealers who probably have to satisfy that requirement, we've got at least a hundred, I've heard numbers of 300 floated around on the buy side who have to trade a smaller, number of trades each year.

These are still really significant numbers. And so what I really want to achieve with the blog is, okay, I got it wrong. It's a nice story to relay on the podcast, but I think the purpose of our listeners going away to read the blog is to look at these numbers and to put them in context. If I was to provide kind of a single soundbite, I'd say that "Compared to current Eurex volumes, we're talking about increasing those by about 25%." Now that would assume that none of the current Eurex volumes are satisfying the active account requirement. So I do think that the calibration of it has been carefully thought of, and it's not that scary from a size perspective, but I would say that the writing of those requirements should have been a little bit clearer.

Mark, I'm sure you've got some questions. Number one, how did I get it wrong? I'm sure, but I will hand it over to you. 

Mark Bell: Well, maybe I should start by, I was surprised that Chris got it wrong, but then you think, uh, a couple of podcasts ago, we spoke about your 500th blog. We've got two wrong in the last 500.

We're running at what? 99. 6%. I think that's a reasonable number. I think if my kids got that in school, I'd be pretty happy. The first question is you spoke about the dealer size and what the dealer volume is. The measures came out in notional as opposed to DV01. So would it be correct to assume that not really too much of an impact on dealers, they would continue as they are now with a little bit more trade volume going through, but the end users are going to require to sort of start clearing at a European-based clearinghouse. Is that going to mean that they would probably move the cost of clearing at a European-based clearinghouse or two clearinghouses versus one, is probably the biggest impact of this reg.

What's your view on that? 

Chris Barnes: My view is having a looked at the numbers, I think it's very likely that all dealers already satisfying it and most dealers, well, all of the top 25 will already be members of EUREX OTC anyway, so I don't see it impacting dealers that much. You've hit the nail on the head though, where you start looking at clients and potentially at the bottom end, do they want to split their clearing?

Do they want to maintain two relationships? Or do they want to just use a single one? If they use a single one, obviously there's only a regulatory mandate to trade onshore. And so there is a possibility over time that this results in more clients joining exclusively Eurex. But it's really hard to say on day one that you would transfer your business from LCH as a result of this, right?

Which is why I say I think a lot of careful thought has been put into calibrating these sizes as a first step. 

Mark Bell: The next question is, is there going to be some sort of basis between LCH and Eurex? And would we even be appropriate to call that a regulatory basis, in that people are being forced to do what they have to do?

Chris Barnes: I think the only parallel I would draw is to LCH JSCC. Who has that similar market dynamic whereby effectively domestic accounts need to trade at the domestic CCP? We saw in the early days that the CCP basis in yen was really volatile. We saw when rates in yen were so low, that CCP basis was like the major pain point really, and it was the biggest difference from day to day, whilst rates were flatlining. Will we see the same in Europe? Really hard to tell because it's a quite developed market already. It's had a lot of volatility in the past. It's a lot tighter now than it has been historically. That suggests that EUREX are doing a great job of creating a balanced franchise anyway.

I do think that it's a key, key measure of success, let's say. You know, a good policy, a good onshoring policy would result in balanced flows, which would argue that the CCP basis should not be that volatile and should be relatively tight. If we start to see CCP basis moving out. That can only really be as a response of these regulations.

And I think it would be a negative mark against the regulators if that happened. 

Mark Bell: Thanks very much. 

Chris Barnes: Pleasure. Hopefully I got those answers right. And hopefully for the next 500 blogs, I can improve the accuracy from 99. 6 percent to a hundred percent. On that note, Ali, over to you. 

Ali Curi: Well, thank you, Chris. And having corrected your wrongness, please share with us again the title of your blog post.

Chris Barnes: That's the "European Active Account Requirements Revisited." It's really important for the "revisited" bit because the other one was wrong. 

Ali Curi: Great, that works. Chris Barnes, Mark Bell, thank you both for sharing your Quick Takes. Let's do it again next week.

Chris Barnes: Look forward to it, Ali. Thanks a lot. 

Mark Bell: Thanks, Ali. 

Ali Curi: And that's our episode for today.

You can read more about these topics on the Clarus blog, and you can follow ION Markets on X and on LinkedIn. Thank you for joining us.