EMIR clearing obligation

 


 

 

The obligation to clear certain classes of OTC derivatives in Central Counterparties (CCPs) that have been authorised (for European CCPs) or recognised (for third-country CCPs) under the European Market Infrastructure Regulation ("EMIR") framework reflects the overarching objectives to reduce financial infrastructure systemic risks.  

 

This regulatory policy framework is intended to drastically rebuild the existing OTC market infrastructure.

 

While the estimated value of total gross notional outstanding for non-centrally cleared derivative activities is about EUR 146 trillion (see Draft Impact Assessment to ESAs' Second Consultation on margin RTS for non-cleared derivatives of 10 June 2015 p. 64), this figure is expected to decrease to about EUR 74.9 trillion (or by 49%) after the implementation of the central clearing obligation, which will require about half of these transactions to be subject to mandatory central clearing.

 

In other words, after the implementation of the margin requirements, about 49% of the OTC derivatives market will be captured by the EMIR collateral requirement, and the remaining 51% will be cleared centrally.

 

 

Under EMIR, OTC derivatives transactions that have been declared subject to a clearing obligation must be cleared centrally through a CCP authorised or recognised in the Union.


Article 4(1)(b) of EMIR mandates the clearing of the OTC derivative contracts (pertaining to a class of OTC derivatives that has been declared subject to the clearing obligation) that are entered into or novated either on or after the date from which the clearing obligation takes effect or during the frontloading period detailed in Article 4(1)(b)(ii) (see below) and under certain conditions.

 

The European Securities and Markets Aurhority (ESMA) underlined all types of trade novations are covered by the clearing obligation laid down in Article 4 of EMIR, i.e. it applies each time a counterparty (being a CCP or another counterparty) steps into the trade and become a new counterparty to the trade.

 

 

Procedure for defining classes of OTC derivatives subject to the clearing requirement

 

 

The process at issue requires in the first place proper identification of classes of derivatives that should be subject to mandatory clearing.

 

The prominent role in that regard EMIR reserves to the European Securities and Markets Authority (ESMA), which, in accordance with the clearing obligation procedure of Article 5 of EMIR, is entrusted with the task to develop and submit to the European Commission for endorsement draft technical standards specifying:

Clearing-obligation-emir- the class of OTC derivatives that should be subject to the clearing obligation referred to in Article 4;

- the date or dates from which the clearing obligation takes effect, including any phase in and the categories of counterparties to which the obligation applies; and
- the minimum remaining maturity of the OTC derivative contracts referred to in Article 4(1)(b)(ii).

 

It follows, EMIR clearing obligation applies to derivatives determined in the special procedure only as "not all CCP-cleared OTC derivative contracts can be considered suitable for mandatory clearing" (Recital 15 of EMIR).

 

It needs to be underlined there is no automatic inclusion of the authorised classes directly into the clearing obligation, but EMIR defines the "process of identification of classes of derivatives that should be subject to the clearing obligation", based on a series of criteria to base the analysis on.

 

Following the said procedure after reviewing this first set of authorised classes against the EMIR criteria, ESMA has determined a subset of classes to be subject to the clearing obligation. On the contrary, several classes, are currently determined to be not fit for the clearing obligation.

 

What needs to be stressed, EMIR requires ESMA to define contracts subject to the clearing obligation as opposed to the conditions under which the contracts are subject to the clearing obligation as those conditions are already defined under the Level 1 text. 

 

Under the bottom-up approach, ESMA determines the classes of over-the-counter (OTC) derivative contracts subject to the clearing obligation among the classes that are already cleared by central counterparties (CCPs).

 

This process is ignited by the initial authorisation of an EU CCP, as well as any extension of CCP activities, and by the recognition of a third-country CCP.

 

Under the top-down approach, ESMA identifies classes of OTC derivatives that should be cleared, but for which no CCP has developed an offer. Moreover, ESMA publishes a call for a development of proposals for the clearing of those classes.

 

 

As the EMIR Review Report no.4 - ESMA input as part of the Commission consultation on the EMIR Review  (2015/1254) underlines, the clearing obligation "relies on a pre-condition, which is the authorisation of CCPs or the recognition of TC-CCPs under EMIR. Indeed, counterparties can only be mandated to clear certain classes of OTC derivatives when there are CCPs meeting certain standards and that have been authorised to clear these classes. The bottom-up procedure of Article 5(2) is built on this principle. Indeed, the authorisation or the recognition of a CCP is the trigger of the bottom-up procedure to determine the classes, amongst those classes the CCP is authorised to clear, that should become subject to the clearing obligation."

 

For each of these procedures, ESMA has up to six months from the time of the notifications to draft the respective regulatory technical standards (RTS), consult thereon and submit draft RTS for endorsement to the European Commission.

 

In practice, in the four consultation papers released so far (see below) ESMA applied a "grouping approach" consisting in that instead of triggering the procedure each time a CCP was authorised, as long as the different authorisations were not too far apart and as long as the classes were in the same asset class or in the same product type range, ESMA analysed and consulted on sets of classes that would span across a range of CCPs.

 

After the Commission's endorsement, the RTS are subject to a non-objection period by both the European Council and Parliament, after which the clearing obligation will be phased-in per type of counterparties.

 

The first procedure of this kind have started on 18 March 2014 following the re-authorisation under EMIR of Nasdaq OMX Clearing AB as the first EU-based CCP on 18 March 2014. In accordance with the procedure laid out under Article 5(1) of EMIR, ESMA was notified of the fact including the classes of OTC derivatives cleared by Nasdaq OMX Clearing AB - being intrest rates, debt instrument and equity (emission allowances as included in the commodity asset class were subject to this notification).

 

Among the first three European CCPs re-authorised by ESMA under EMIR were also:
- European Central Counterparty N.V. (EuroCCP - NL), Netherlands
- KDPW_CCP, Poland.

 

Subsequent CCPs followed the suit - the full database of European CCPs and of the classes of assets cleared by them can be accessed here.

 

As ISDA Europe Conference Speech by ESMA's Chair Steven Maijoor (2015/1417) observes, half of the European CCPs clear OTC derivatives and almost all of them have since 2014 received regulatory approval from their national competent authorities confirming they comply with the higher standards embedded in EMIR.

 

The significant proposition that has not been included in the binding law so far is the postulate no clearing obligation be imposed unless there are at least 2 CCPs available to clear them.

 

The underlying reason is to avoid a situation of monopoly and the concentration of risk in a single market infrastructure. The conception implies the clearing obligation to be automatically removed in case the number of CCPs available to clear a specific class falls below 2. However, under the current regulatory framework only one CCP available to clear a derivatives' class is sufficient for the clearing obligation to be made applicable.

 

 

Clearing Obligation Public Register

 

 

The Clearing Obligation Public Register contains two types of information:

 

1. The list of the classes of OTC derivatives notified to ESMA - this section of the register was published for the first time on 18 March 2014 after a notification was received by ESMA under the procedure described in Article 5(1) of EMIR, i.e. following the authorisation of the first CCP to clear certain classes of OTC derivatives. This part of the Public Register is updated after each CCP authorisation.

 

The European financial regulator's task will be in each case to assess whether the classes of OTC derivatives notified meet the criteria defined in EMIR, and, if the conditions prove fulfilled, to propose draft regulatory technical standards (RTS) on the clearing obligation with respect to those classes of assets.

It is noteworthy, the clearing obligation procedure defined in Article 5(2) of EMIR is triggered every time a new CCP clearing OTC derivatives is authorised. In this type of procedure ESMA will only assess the suitability of classes notified. 

Clearing-obligation-classes

 

This means that if CCPs are authorised on different dates, several clearing obligation procedures may run in parallel. 

 

The classes of OTC derivatives listed may become subject to the clearing obligation in accordance with the clearing obligation procedure defined in Article 5 of EMIR and be added to the public register when the relevant Regulatory Technical Standards enter into force.

 

2. The list of classes subject to the clearing obligation - this section of the register will be published immediately after the entry into force of the RTS specifying the classes of OTC derivatives subject to the clearing obligation.

 

These RTS will be adopted following the procedure described in Article 5(2) of EMIR.

 

Clearing Obligation Public Register can be accessed here.

 

 

Classes of OTC derivatives subject to the clearing obligation

 

 

Increasingly supported by data retrieved from European Trade Repositories, ESMA is in the process of analysing contracts that are currently offered for clearing by European CCPs, to determine whether they meet the criteria defined in EMIR to be subject to the clearing obligation (which relate to standardization, liquidity, and availability of pricing information).

 

Based on the above-described procedure and legal requirements ESMA consulted so far on the clearing obligation for Interest Rate Derivatives (IRS), Credit Default Swaps (CDS) and Non-Deliverable Forwards (NDFs) instruments already, while commodity derivatives have not yet been proposed by ESMA for mandatory clearing. 

 

A first set of rules will require counterparties to clear interest rate swaps (IRS) denominated in EUR, GBP, JPY and USD (the "G4 currencies"). The second set of rules under EMIR will require mandatory clearing of certain Index Credit Default Swaps (CDS).

 

Interest Rate Derivatives (IRS)

 

Interest rate derivatives represent the significant portion of the market as this asset class concentrates approximately 80% of the total volumes of OTC derivatives.

ESMA launched a public consultation in July 2014 (ESMA/2014/799 published on 11 July 2014) and in October 2014 submitted to the European Commission its final proposal (ESMA/2014/1184 published on 1 October 2014) to impose a clearing obligation on several classes of interest rate swaps denominated in the G4 currencies (EUR, GBP, JPY and USD).

Certain aspects of the clearing obligation for IRS sparked, however, vivid discussion between ESMA and the European Commission (ESMA's Opinion Draft RTS on the Clearing Obligation on Interest Rate Swaps of 29 January 2015 (2015/ESMA/223) and ESMA's Revised Opinion Draft RTS on the Clearing Obligation on Interest Rate Swaps of 6 March 2015 (2015/ESMA/511)), mainly due to the need to amend the timeline of entry into force and introduce a special carve-out for intragroup transactions concluded with non-EU counterparties.

 

Finally, the European Commission adopted on 6 August 2015 (see the European Commission press release of 6 August 2015) a Delegated Regulation that requires mandatory clearing through central counterparties for the following types of over-the-counter (OTC) interest rate derivative contracts denominated in the G4 currencies (GBP, EUR, JPY and USD):

- Fixed-to-float interest rate swaps (IRS), known as 'plain vanilla' interest rate derivatives,
- Float-to-float swaps, known as 'basis swaps',
- Forward Rate Agreements,
- Overnight Index Swaps.

 

The specific classes within the scope as well as specific features (among others the index used as a reference for the derivative, its maturity, and the notional type) were set out in the Annex to the Delegated Regulation.

 

The Regulation envisioned for the phase-in the clearing obligation for the above G4 currencies over a period of three years according to counterparty category (as well as the frontloading requirement for financial counterparties in categories 1 and 2).

 

The said Delegated Regulation after a scrutiny by the European Parliament and the Council has been published in the Official Journal of the European Union with the entry into force on the twentieth day following publication (Commission Delegated Regulation (EU) 2015/2205 of 6 August 2015 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on the clearing obligation). This legislative act is sometimes called: "First Delegated Regulation on the clearing obligation".

 

Furthermore, ESMA launched a public consultation in May 2015 (ESMA/2015/807 published on 11 May 2015) with a proposal to extend the scope of IRS to 6 other currencies, namely the Czech Koruna (CZK), Danish Krone (DKK), Hungarian Forint (HUF), Norwegian Krone (NOK), Polish Zloty (PLN) Swedish Krona (SEK).

 

This was followed by the Final Report Draft technical standards on the Clearing Obligation – Interest rate OTC Derivatives in additional currencies, of 10 November 2015 (ESMA/2015/1629), which proposed a clearing obligation for fixed-to-float interest rate swaps denominated in NOK, PLN and SEK and forward rate agreements denominated in NOK, PLN and SEK. 

 

The said ESMA's Report findings as regards the clearing obligation for NOK, PLN and SEK have been implemented in the Commission Delegated Regulation of 10.6.2016 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on the clearing obligation, C(2016) 3446 final (Annex is available here).

 

The said Regulation has been published in the Official Journal of the European Union on 20 July 2016 (Commission Delegated Regulation (EU) 2016/1178 of 10 June 2016 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on the clearing obligation). This Regulation comes as the third delegated act on the clearing obligation as, in the meantime, the separate regulation stipulated the clearing obligation on CDS asset classes (see below).

 

See more on the clearing obligation for IRS...

 

Credit Default Swaps (CDS)

 

When it comes to the Credit Default Swaps (CDS) asset class, ESMA consulted stakeholders in July 2014 on a proposal for mandatory clearing on certain CDS indices (ESMA/2014/800 published on 11 July 2014, the index CDS included are untranched iTraxx Europe Main and iTraxx Europe Crossover with 5Y tenor).

 

Although the feedback received to this consultation was broadly positive, ESMA temporarily suspended the delivery of the final proposal to the European Commission until the first rules on the clearing obligation for IRS are finalised.

 

On 2 October 2015 ESMA finalised and issued a draft Regulatory Technical Standard for CDS, which has been adopted by the European Commission on 1 March 2016 (Commission Delegated Regulation (EU) 2016/592 of 1 March 2016 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on the clearing obligation - sometimes called: "Second Delegated Regulation on the clearing obligation".

 

The said standard defines types of CDS contracts, which will have to be centrally cleared, the types of counterparties covered by the obligation and the dates by which central clearing of CDS will become mandatory.

 

In effect wo iTraxx Index CDS have been subjected to the clearing obligation:
- Untranched iTraxx Index CDS (Main, EUR,5Y)
- Untranched iTraxx Index CDS (Crossover, EUR,5Y).


The new rules on Index CDS mirror the overall approach of the first RTS on IRS, in particular with regards to the categorisation of counterparties, the scope for frontloading and the treatment of intragroup transactions.

 

More detailed information of the specific parameters of the mandatory clearing for OTC Credit Default Swaps (CDS) is available here.

  

Non-Deliverable Forwards (NDFs) nad equity derivatives

 

ESMA issued a consultation paper in October 2014 (ESMA/2015/1185 published on 1 October 2014) with a proposal of mandatory clearing for certain FX products, namely non-deliverable forwards, or NDFs.

 

Based on the feedback received, ESMA has concluded that more time would be needed to address the concerns raised in the responses, and has decided not to propose a clearing obligation on those classes at this stage (ESMA's Feedback Statement of 4 February 2015, 2015/ESMA/234).

 

Similarly, ESMA did not propose draft regulatory technical standards to make equity derivatives subject to the clearing obligation.

 

General remarks on classes of OTC derivatives subject to the clearing obligation

 

Overall, the scope of the clearing obligation may expand in future to other currencies but also possibly to other classes as CCPs gradually develop their clearing offer (see Verena Ross, Executive Director, European Securities and Markets Authority, Keynote speech at IDX 2015, London, 09 June 2015 ESMA/2015/921).

 

To summarise, the legislative system regarding derivatives subject to the mandatory clearing may seem complicated and not user-friendly.

 

It consists of several independent and separate RTS.

 

There are separate RTS even for derivatives within the same asset class (IRS).

 

The verification of multiple regulations to establish which asset classes are subject to the clearing obligation and whether the provisions are final and binding or in the legislative procedure yet, appears onerous.

 

To cope with this problem ESMA's Report of 10 November 2015 (ESMA/2015/1629, p. 6) underlines the list of classes subject to the clearing obligation is consolidated in one place - the Public Register available on the ESMA website.

 

Therefore, consolidated and central place of information for the list of classes subject to the clearing obligation is not intended to be achieved via an RTS, but it is provided for by the ESMA's Public Register.

 

 

Clearing obligation phase-in periods

 

 

The distribution of trades among financial counterparties is highly concentrated, i.e. that a relatively small number of counterparties account for an important share of the total market.


This asymmetry was one of the justifications for the adoption of a phased-in implementation schedule for the clearing obligation, i.e. starting with the few but most active counterparties (clearing members) and adding progressively an increasing number of less active counterparties.

 

This asymmetric distribution is present in both asset classes that first became subject to the clearing obligation i.e. the interest rate and the credit asset classes, where the largest 100 counterparties accounted for 96%-97% of the OTC derivative volume, measured by outstanding notional amounts (Consultation Paper on the clearing obligation for financial counterparties with a limited volume of activity, 13 July 2016, ESMA/2016/1125, p. 12).

 

The milestones for the staged implementation of the clearing obligation are set out in the table below.

    

Category
 Entities covered 

Commission Delegated Regulation (EU) 2015/2205 of 6 August 2015 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on the clearing obligation

(G4 currencies)

Commission Delegated Regulation (EU) 2016/592 of 1 March 2016 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on the clearing obligation

(European Index CDS)

 

Commission Delegated Regulation (EU) 2016/1178 of 10 June 2016 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on the clearing obligation

(NOK, PLN, SEK)

 1

 

Clearing members for at least one of the classes of OTC IRS subject to clearing

 

21 June 2016

 9 February 2017

 9 February 2017

2

 

Financial counterparties and alternative investment funds (AIFs) which are not clearing members and which have a higher level of activity in OTC derivatives (to be measured against a quantitative threshold

 

21 December 2016  9 August 2017   9 July 2017 
3

 

Financial counterparties and alternative investment funds (AIFs) which are not clearing members and which have a lower level of activity in OTC derivatives (to be measured against a quantitative threshold)

 

Dates in brackets comprise the amended deadlines for Category 3 counterparties as set out in the

 

Final Report on the clearing obligation for financial counterparties with a limited volume of activity, 14 November 2016, ESMA/2016/1565 and

 

Commission Delegated Regulation (EU) of 16.3.2017 amending Delegated Regulations (EU) 2015/2205, (EU) 2016/592 and (EU) 2016/1178 as regards the deadline for compliance with clearing obligations for certain counterparties dealing with OTC derivatives, 16.3.2017 C(2017) 1658 final

 

21 June 2017 

(21 June 2019)

9 February 2018 

(21 June 2019)

9 February 2018

(21 June 2019)

4

 

Non-financial counterparties not included in the other categories

 

21 December 2018   9 May 2019  9 July 2019

 

(Note: where a contract is concluded between two counterparties included in different categories of counterparties, the date from which the clearing obligation takes effect for that contract shall be the later date)

 

 

In the aforementioned ESMA's Consultation Paper of 13 July 2016 on the clearing obligation for financial counterparties with a limited volume of activity (ESMA/2016/1125) ESMA proposed a two-year postponement of the date of application of the clearing obligation for Category 3, compared to the dates that are currently set out in the Delegated Regulations.


Indeed, delaying the application of the clearing obligation by 2 years for counterparties in Category 3 means that the deadline for this category of counterparties would come after that of Category 4 (comprising non-financial counterparties above the clearing threshold).

 

It may be questionable that the proposed delay of the clearing obligation is only for Category 3 counterparties, while the clearing obligation for Category 4 counterparties (being mostly less sophisticated entities) would remain unchanged and enter into force 6 months before the obligation for Category 3 counterparties.

 

However, ESMA's Final Report on the clearing obligation for financial counterparties with a limited volume of activity of 14 November 2016, ESMA/2016/1565 upheld this approach arguing Category 4 counterparties are sometimes much more sophisticated than the ones in the Category 3 and pointing out minor systemic relevance of Category 3 counterparties, which represent only 5.1% of the volume on the CDS market versus 1.1% of the volume in the IRS market.

 

ESMA, moreover, proposed in the Final Report to align the three compliance dates for Category 3 in the three Delegated Regulations on IRS and CDS.

 

As a result, compared to the Consultation paper, ESMA has modified in its Final Report the compliance date for Category 3 in the Delegated Regulation on IRS denominated in NOK, PLN and SEK and in the Delegated Regulation on CDS.

 

This uniform compliance date for Category 3 is now 21 June 2019.

 

The above legislative propositions are upheld by the Commission Delegated Regulation (EU) of 16.3.2017 amending Delegated Regulations (EU) 2015/2205, (EU) 2016/592 and (EU) 2016/1178 as regards the deadline for compliance with clearing obligations for certain counterparties dealing with OTC derivatives, 16.3.2017 C(2017) 1658 final.

 

 

Counterparties classification

 

 

 

Recitals 4 - 8 of the Commission Delegated Regulation (EU) 2015/2205 of 6 August 2015 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on the clearing obligation

 

(4) Different counterparties need different periods of time for putting in place the necessary arrangements to clear the interest rate OTC derivatives subject to the clearing obligation. In order to ensure an orderly and timely implementation of that obligation, counterparties should be classified into categories in which sufficiently similar counterparties become subject to the clearing obligation from the same date.

 

(5) A first category should include both financial and non-financial counterparties which, on the date of entry into force of this Regulation, are clearing members of at least one of the relevant CCPs and for at least one of the classes of interest rate OTC derivatives subject to the clearing obligation, as those counterparties already have experience with voluntary clearing and have already established the connections with those CCPs to clear at least one of those classes. Non-financial counterparties that are clearing members should also be included in this first category as their experience and preparation towards central clearing is comparable with that of financial counterparties included in it.

 

(6) A second and third category should comprise financial counterparties not included in the first category, grouped according to their levels of legal and operational capacity regarding OTC derivatives. The level of activity in OTC derivatives should serve as a basis to differentiate the degree of legal and operational capacity of financial counterparties, and a quantitative threshold should therefore be defined for division between the second and third categories on the basis of the aggregate month-end average notional amount of non-centrally cleared derivatives. That threshold should be set out at an appropriate level to differentiate smaller market participants, while still capturing a significant level of risk under the second category. The threshold should also be aligned with the threshold agreed at international level related to margin requirements for non-centrally cleared derivatives in order to enhance regulatory convergence and limit the compliance costs for counterparties. As in those international standards, whereas the threshold applies generally at group level given the potential shared risks within the group, for investment funds the threshold should be applied separately to each fund since the liabilities of a fund are not usually affected by the liabilities of other funds or their investment manager. Thus, the threshold should be applied separately to each fund as long as, in the event of fund insolvency or bankruptcy, each investment fund constitutes a completely segregated and ring-fenced pool of assets that is not collateralised, guaranteed or supported by other investment funds or the investment manager itself.

 

(7) Certain alternative investment funds ('AIFs') are not captured by the definition of financial counterparties under Regulation (EU) No 648/2012 although they have a degree of operational capacity regarding OTC derivative contracts similar to that of AIFs captured by that definition. Therefore AIFs classified as non-financial counterparties should be included in the same categories of counterparties as AIFs classified as financial counterparties.

 

(8) A fourth category should include non-financial counterparties not included in the other categories, given their more limited experience and operational capacity with OTC derivatives and central clearing than the other categories of counterparties.

 

The existing system of counterparty classification was designed taking into consideration the criteria set up in EMIR, in particular:

 

- the level of sophistication of the counterparties and the type and number of counterparties active in the relevant OTC derivative markets (criteria (d) of Article 5(5) of EMIR), and

 

- the differences in the legal and operational capacities of the counterparties (criteria (f) of Article 5(5) of EMIR).

 

Besides clearing members, financial counterparties have been grouped according to their levels of legal and operational capacity regarding OTC derivatives, which was approximated by the level of activity of the counterparties in OTC derivatives.

 

Category 2 is distinguished from Category 3 based on quantitative threshold to differentiate small from large market participants, while still capturing a significant level of risk under the Category 3 (Recital (6) of the Commission Delegated Regulation (EU) 2015/2205 of 6 August 2015 and the Commission Delegated Regulation (EU) 2016/1178 of 10 June 2016, and Recital (5) of the Commission Delegated Regulation (EU) 2016/592 of 1 March 2016).

 

This quantitative threshold is set uniformly across all three delegated regulations adopted so far, at the level of EUR 8 billion (aggregate month-end average of outstanding gross notional amount of non-centrally cleared derivatives for January, February and March 2016 - assessed at a group level).

 

The assessment at group level "was introduced at international level as a tool to dissuade avoidance practice, consisting of splitting an entity into smaller sub-entities each below the relevant threshold" (Final Report on the clearing obligation for financial counterparties with a limited volume of activity, 14 November 2016, ESMA/2016/1565p. 15).

 

Another consideration are potential shared risks within the group.

 

However, for investment funds the EUR 8 bn threshold applies separately to each fund since the liabilities of a fund are not usually affected by the liabilities of other funds or their investment manager.

 

Counterparties in Category 1 can be easily identified, as the classification of counterparties in Category 1 (clearing members) was made publicly available by all CCPs which are clearing the OTC derivatives subject to the clearing obligation, see the Public Register for the clearing obligation under EMIR).

 

In turn, the counterparty classification between Category 2 and 3 is much more complex and could only be approximated on the basis of a number of assumptions (Consultation Paper on the clearing obligation for financial counterparties with a limited volume of activity, 13 July 2016, ESMA/2016/1125, p. 18).

 

As the consequence of common assumptions, all three delegated regulations on the clearing obligation adopted so far, share almost identical reasoning as regards counterparties classification. This is expressed in:

 

- Recitals 4 - 8 of the Commission Delegated Regulation (EU) 2015/2205 of 6 August 2015 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on the clearing obligation,

 

- Recitals - 4 - 8 Commission Delegated Regulation (EU) 2016/1178 of 10 June 2016 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on the clearing obligation, and

 

- Recitals 3 - 7 of the Commission Delegated Regulation (EU) 2016/592 of 1 March 2016 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on the clearing obligation.

 

See in the box an exemplary citation from the Commission Delegated Regulation (EU) 2015/2205 of 6 August 2015.

 

 


 

 

 

Process for removing a derivative contract from the scope of the clearing obligation

 

 

There is also a controversy regarding the procedure to be followed-up on the occasion of removing a derivative contract from the scope of the clearing obligation. The only possibility foreseen by EMIR in such a case is to modify the relevant RTS.

 

However, while it was less contentious that the addition of a new derivatives' class should exclusively be possible via the full RTS procedure, it is sometimes argued that the RTS procedure, due to its prolonged character, would not be appropriate in case where there is an urgent need to remove a specific derivatives' class already included in the clearing obligation from its scope.

 

ESMA Final Report Draft technical standards on the Clearing Obligation – Interest Rate OTC Derivatives of 1 October 2014 (ESMA/2014/1184) invokes a number of reasons why ESMA may need to act as a matter of urgency to remove a specific class from the clearing obligation, in particular:

 

- a drop in the liquidity of the contracts leading the CCPs to impose extremely high margin requirements,

 

- a situation where a CCP is no longer authorised/recognised or ceases to clear a specific derivatives' class and the other CCPs are unable to absorb the resultant trade activity or stressed market conditions leading to clearing member defaults.

 

The RTS on the clearing obligation is not an appropriate instrument address this problem since it would be beyond the empowerment for ESMA under EMIR.

 

The first occasion on which the clearing obligation process may be modified to accomodate the above suggestions is the EMIR review process to be performed in 2015.

 

The said modification is rather probable as ESMA has expressed several times the view that the lack of an agile mechanism to suspend the clearing obligation may bring additional risks to markets. 

 

As a result ESMA will seek to insist, including in the review process of EMIR, to ensure that a more efficient and flexible process is built for the removal of the clearing obligation.

 

On that occasion the process for the establishment of the said obligation may also be affected.

 

Updates of the public register for the clearing obligation are available by subscribing to the ESMA website and creating alerts. An email is then sent every time a new document is published by ESMA.

 

 

Transitory issues - frontloading

 

 

Interesting considerations of business risks of a general nature involved with the process for phasing in the mandatory clearing under EMIR are included in the recitals to the first approaching draft regulatory technical standards finalised.

 

The fact these regulatory technical standards are IRS-specific does not rectrict the broader applicability of this thread given the recurring character of the phasing-in procedure, separate for each class of OTC derivatives.

 

The source of the said risk is embedded in the EMIR Regulation itself as the level 1 legislation imposes the clearing requirement not only on contracts entered into or novated on or after the date from which the clearing obligation takes effect, but also on contracts concluded after the notification to ESMA that follows the authorisation of a CCP to clear a certain class of OTC derivatives, but before the date on which the clearing obligation takes effect, provided the remaining maturity of such contracts at the date on which the obligation takes effect justifies it - Article 4(1)(b)(ii) (provision applicable to financial counterparties only).

 

The above-mentioned minimum remaining maturities are specified by the European Commission in the delegated acts.

 

 

Mandatory Clearing - Minimum Remaining Maturity

 

minimum remaining maturity emir co

 

     Source of the table:

     Discussion Paper, The trading obligation for derivatives under MiFIR, 20 September 2016, ESMA/2016/1389, p. 28

 

 

The term "frontloading" in this context refers to the obligation to clear contracts in the latter period. 

 

The problem involved is comprised by the regulator in the following words:


"Before regulatory technical standards adopted pursuant to Article 5(2) of Regulation (EU) No 648/2012 enter into force, counterparties cannot foresee whether the OTC derivative contracts they conclude would be subject to the clearing obligation on the date that obligation takes effect. This uncertainty has a significant impact on the capacity of market participants to accurately price the OTC derivative contracts they enter into since centrally cleared contracts are subject to a different collateral regime than non-centrally cleared contracts."

 

Given the above complexities the IRS framework for mandatory clearing start-up had been arranged via an exchange of letters between ESMA and the European Commission (the European Commission's letter to ESMA of 18 December 2014) excluding frontloading until legal certainty is reached on the exact set of classes subject to the clearing obligation and the CCPs authorised to clear them.

 

It was, moreover, agreed between the European Commission and ESMA that the certainty would be reached no later than on the date of publication of the RTS in the Official Journal of the Union hence that the frontloading obligation could not be delayed beyond that date.

 

Conseqently, the frontloading period has been further divided into two parts with divergent legal consequences:

 

- the period between the notification to ESMA and the publication of the relevant RTS in the Official Journal;

 

and

 

- the period following the publication of the relevant regulatory technical standards in the Official Journal and the date on which the clearing obligation takes effect.


OTC derivative contracts entered into within the former period will not be subject to the frontloading requirement, while OTC derivative contracts entered into in the latter one may be subject to the frontloading obligation depending on the minimum remaining maturity as at the date of the application of the clearing obligation for that OTC derivative contract.

 

The reason why the frontloading obligation should not apply immediately after the notification of the classes to ESMA are the pricing complexities related to the uncertainty of a possible forward clearing requirement. As the European Commission observed in its letter to ESMA of 18 December 2014, "counterparties need time to calculate the price of the frontloading to include it in their contracts and communicate their counterparties whether they are subject to the frontloading requirement".

 

Counterparties, moreover, need time to analyse their contracts whether they are subject to the clearing frontloading obligation as well as implement necessary arrangements for the frontloading to take place.

 

Given the categories of counterparties are also differentiated with the use of thresholds, there is sufficient time necessary to carry out the adequate calculations.

 

According to the Level 1 requirement the frontloading obligation only applies to financial counterparties, consequently non-financial counterparties remain beyond the scope.

 

The European Commission's propositions as regards the reform of the EMIR framework published in May 2017 provide for the removal of frontloading requirements (see point (b) of Article 1(2) the Proposal for a Regulation of the European Parliament and of the Council amending Regulation (EU) No 648/2012 as regards the clearing obligation, the suspension of the clearing obligation, the reporting requirements, the risk-mitigation techniques for OTC derivatives contracts not cleared by a central counterparty, the registration and supervision of trade repositories and the requirements for trade repositories, COM(2017)208 of 4 May 2017).

 

 

Clearing obligation with respect to swaps resulting from the exercise of a swaption 

 

 

A swap which results from the exercise of a swaption is subject to the clearing obligation when any of the following conditions are met:

 

(i) the swap and the corresponding swaption are entered into on or after the date on which the clearing obligation takes effect; or

 

(ii) the swap is entered into on or after the date on which the clearing obligation takes effect and the corresponding swaption is entered into on or after the date on which the frontloading obligation starts to apply and before the date on which the clearing obligation takes effect; or

 

(iii) the swap and the corresponding swaption are entered into on or after the date on which the frontloading obligation starts to apply and before the date on which the clearing obliga-tion takes effect, and the swap has a remaining maturity which is higher than the minimum remaining maturity defined in the RTS on the clearing obligation.

 

The table below summarises different cases (source: ESMA's EMIR Q&As, OTC Question 20).

 

Before "frontloading window" 

 During "frontloading window"

On or after date on which the clearing obligation takes effect

 

Is the swap resulting from the swaption

subject to the clearing obligation?

    Swaption entered into and exercised 

Yes (i)

 

 

 

Swaption entered into 

 

 Swaption exercised 

 

Yes (ii)

 
Swaption entered into and exercised  

Yes if the swap has a remaining maturity

above the minimum remaining maturity defined in the RTS (iii)

Swaption entered into

 Swaption exercised  

No

 

Swaption entered into

 

  Swaption exercised

No

 

 

Mandatory clearing application problems

 

 

Among the entire spectrum of practical issues involved with the process for implementation of the clearing obligation, the following deserve to be accounted for in the first place:

 

Mandatory clearing means essential elements of the OTC contracts, including the pricing of interest rate OTC derivatives subject to the clearing obligation and concluded before that obligation takes effect, will have to be adapted within short timeframes in order to incorporate the clearing.

 

This process of forward-clearing involves important adaptations to the pricing models and amendments to the documentation of OTC derivatives contracts, providing appropriate representations, and making relevant changes to systems, controls and internal procedures to reflect these determinations and representations.

 

Thus, counterparties need to analyse their portfolios to identify contracts potentially subject to this requirement (taking account of their counterparties' statuses).

 

Mandatory clearing preparation phase represents, moreover, the appropriate moment to examine whether the intragroup exemption could be applied under circumstances and whether its use is adequate to the company's business model (see more on intragroup exemption from mandatory clearing). 

 

In the case the above analysis shows the counterparty is within the scope of application of mandatory clearing, the need to arrange for the necessary clearing relationships arises.

 

Overall, the first, relatively advanced, draft RTS on mandatory clearing, i.e. the one relating to IRS instruments, rises impression the onus is on financial counterparties rather, since, as was said above, the non-financial counterparties are not covered by the the frontloading requirement, furthermore, the date from which the clearing obligation with respect to IRS takes effect on non-financial counterparties not being a clearing members (representing the category 4) is 3 years from the date of entry into force of the relevant Regulation, that is a relatively long period (for other categories of counterparties these deadlines vary from 6 to 18 months). 

 

In turn, clearing members (comprised in category 1) already posess the necessary organisational and legal infrastructure to fulfill all requirements involved with mandatory clearing, hence, new requirements will not necessarily be particularly burdensome for them.

 

Another nuance deserving some attention are 'OTC derivative' terminology complexities. ESMA referred to this issue in Q&As on EMIR Implementation OTC Q.1 (d), where the financial regulator clarified the following:

 

"Derivatives transactions, such as block trades, which are executed outside the trading platform of the regulated market, but are subject to the rules of the regulated market and are executed in compliance with those rules, including the immediate processing by the regulated market after execution and the clearing by a CCP, should not be regarded as OTC derivatives transactions. Therefore, these transactions should not be considered for the purpose of the clearing obligation and the calculation of the clearing threshold by NFC that only relates to OTC derivatives.
Derivatives transactions that do not meet the conditions listed in the first paragraph of this sub-answer (d) should be considered OTC. For example, derivatives contracts that are not executed on a regulated market and are not governed by the rules of an exchange at the point of execution should be considered OTC even if after execution they are exchanged for contracts traded in a regulated market. However, the replacement contract itself may be considered exchange traded if it meets the relevant conditions."

 

See here for detailed remarks on different forms of market access to fulfill the clearing obligation.

 

 

How to report clearing obligation in the EMIR trade reports

 

 


The indication whether the reported trade is subject to the clearing obligation initially was populated in Field 28 in the Table 2 (Common data) of the EMIR transactions reporting format.

 

Subsequently, under amendments made by:

 

- Commission Delegated Regulation (EU) 2017/104 of 19 October 2016 amending Delegated Regulation (EU) No 148/2013 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council on OTC derivatives, central counterparties and trade repositories with regard to regulatory technical standards on the minimum details of the data to be reported to trade repositories, and 

 

- Commission Implementing Regulation (EU) 2017/105 of 19 October 2016 amending Implementing Regulation (EU) No 1247/2012 laying down implementing technical standards with regard to the format and frequency of trade reports to trade repositories according to Regulation (EU) No 648/2012 of the European Parliament and of the Council on OTC derivatives, central counterparties and trade repositories;

 

the applicable field is Field 34.

 

This field is intended to be populated with information on "whether the reported contract belongs to a class of OTC derivatives that has been declared subject to the clearing obligation and both counterparties to the contract are subject to the clearing obligation under Regulation (EU) No 648/2012, as of the time of execution of the contract".

 

See here more detailed clarification regarding the population of the "Clearing obligation" field under the EMIR reporting legal framework.

 

 

Clearing obligation under MiFID II/MiFIR 

 

 

In Article 29(1) MiFIR extends the scope of the clearing obligation to all derivative transactions concluded on a regulated market.

 

Under the MiFID II contracts "arising exclusively for clearing or settlement purposes" are intended to be excluded from the scope of the term "transaction" - see Article 2(5)(b) of the Draft regulatory technical standards on reporting obligations under Article 26 of MiFIR).

 

Hence, if the European Commission adopts the ESMA's proposition contained in the said draft RTS, the said contracts will not be reportable under MiFID II reporting scheme.  

 

 

Interconnected points

 

 

Mandatory clearing test, as set up by EMIR, represents the first step for establishing MiFIR trading obligation.

 

 

 



Last Updated on Friday, 19 May 2017 22:18
 

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