Frontloading - the term involved with EMIR Regulation should seriously worry derivatives players these days.



The frontloading requirement is the obligation to clear OTC derivative contracts entered into after a central counterparty (CCP) has been authorised under EMIR and before the date of application of the clearing obligation.


Therefore, the frontloading requirement implies that contracts concluded on a bilateral basis following the authorisation of a CCP might become subject to the clearing obligation before their expiration date.


ESMA letter to the European Commission explains the issue with the following words:


"The frontloading requirement poses a significant challenge from a legal, operational and financial point of view, mainly because of the uncertainty that it creates. Indeed, a transaction that is centrally cleared is subject to a different collateral regime than a transaction that is not, and this has a substantial impact on pricing. This pricing uncertainty may have a number of effects such as a widening of the bid-offer spreads, difficulties or dis-incentive for counterparties to appropriately manage their risks, which may eventually increase risks and reduce market stability.


Besides, during the first part of the frontloading period (Period A i.e. between the notification of the classes to ESMA and the entry into force of the RTS on the clearing obligation), the counterparties do not know whether they will both have access to a common CCP that will end up clearing that contract. The adaptation of contractual terms to allow and adjust to the clearing requirements is also an element that increases the uncertainty linked to frontloading. This period may last between 8 and 15 months." 


The key message is then, derivatives contracts entered into after 18 March 2014 can be subjected to the clearing obligation.


However, which of them does this risk relate to, when this risk will materialise, and which CCPs will be authorised to clear the said contracts, remains uncertain.


No doubt such a situation can be perceived as highly uncomfortable for the industry. It creates, moreover, its own sistemic risks.