When one of the clearing thresholds for an asset class is reached as determined in EMIR, the counterparty is considered as exceeding the clearing thresholds and therefore is subject to the relevant EMIR requirement for all classes of OTC derivative contracts and not only for those pertaining to the class of OTC derivatives where the clearing threshold is exceeded.
But how is the counterparty trading with the non-financial participant (NFC) going to be made aware that the NFC has or has not yet exceeded the clearing threshold?
“EMIR” - European Market Infrastructures Regulation (Regulation of the European Parliament and Council on OTC derivatives, central counterparties and trade repositories) was adopted by the European Parliament on 29 March 2012.
The update reflecting the content of Commission Delegated Regulation (EU) No 149/2013 of 19 December 2012 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on indirect clearing arrangements, the clearing obligation, the public register, access to a trading venue, non-financial counterparties, and risk mitigation techniques for OTC derivatives contracts not cleared by a CCP (OJ L 52, 23.2.2013, p. 11) can be accessed through the following link.
In Article 10 (relating to non-financial counterparties) EMIR provides that where a non-financial counterparty takes positions in OTC derivative contracts and these positions exceed the clearing threshold, that non-financial counterparty should:
(a) immediately notify ESMA and the competent authority thereof;
(b) become subject to the clearing obligation for future contracts if the rolling average position over 30 working days exceeds the threshold;
(c) clear all relevant future contracts within four months of becoming subject to the clearing obligation.
Draft Regulatory Technical Standards on OTC Derivatives – which OTC derivative contracts are ‘objectively measurable as reducing risks directly relating to the commercial activity or treasury financing activity
In this context of utmost importance are the quantitative values and specific rules for calculation of the clearing thresholds proposed by the European Securities and Markets Authority (ESMA) in the Consultation Paper for Draft Technical Standards for the Regulation on OTC Derivatives, CCPs and Trade Repositories of 25 June 2012 available on ESMA’s website (Consultation Paper).
Pursuant to the Consultation Paper the values for clearing thresholds for the clearing thresholds are proposed as follows:
a. EUR 1 billion in notional value for credit derivative contracts;
b. EUR 1 billion in notional value for equity derivative contracts;
c. EUR 3 billion in notional value for interest rate derivative contracts;
d. EUR 3 billion in notional value for foreign exchange derivative contracts;
e. EUR 3 billion in notional value for commodity derivative contracts and other OTC derivative contracts not defined under (a) to (d).
The two elements are of worth of a specific consideration:
- one - that for the purpose of setting the clearing thresholds, the notional value of OTC derivative contracts subject to the clearing obligation is taken into account,
- and the second – consisting in the proposition to set the clearing thresholds per asset class.
Contrary to a net exposure approach, the approach based on the notional amount adds up the nominal value of all outstanding OTC derivative contracts, irrespective of whether they are in or out of the money.
ESMA has also given some explanations as regards why the values of the clearing thresholds are set by reference to the notional amount of the OTC derivative contracts.
According to the Consultation Paper, this approach was preferred due to its simplicity having regard to the non-financial counterparties that may not all have very sophisticated IT systems. The use of the notional amount as a reference explains in ESMA’s view the “high” value of the clearing thresholds.
Calculation per asset classes
The second issue apparent is that for the purpose of the clearing thresholds, 5 asset classes are considered i.e. credit derivatives, equity derivatives, interest rate, foreign exchange and, finally, commodity and others. In that regard ESMA clarified that the clearing obligation would apply to all OTC derivatives contracts concluded after the clearing threshold was exceeded, irrespective of the asset class to which these OTC derivative contracts belong to.
This is an important requirement that does not follow directly from the EMIR text. Nevertheless, if the clearing thresholds are calculated in this manner, it has the potential of changing the current behaviour of market actors.