|Internal Electricity Market Glossary|
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Over-the-counter (OTC) derivatives may be bought for a variety of reasons, for example, they may work as a hedge for a particular position in the balance sheet, or might have been taken with the intent of benefiting from market movements.
The definition of "OTC derivative" is not harmonised at a global level and varies among jurisdictions (Technical Guidance, Harmonisation of the Unique Transaction Identifier, Committee on Payments and Market Infrastructures, Board of the International Organization of Securities Commissions, February 2017, p. 6).
When it comes to the European Union legal framework, pursuant to Article 2(7) of EMIR Regulation, OTC derivatives are defined as derivatives contracts whose execution does not take place on a regulated market (or on a third-country market considered as equivalent to a regulated market in the prescribed manner).
It follows, in particular, under EMIR derivatives contracts whose execution takes place on Multilateral Trading Facility (MTF) are OTC derivatives.
Under Article 2(7) of EMIR, a derivative contract the execution of which takes place on a non-equivalent third-country market is defined as an OTC derivative contract.
The European Securities and Markets Authority (ESMA) in the Q&As on EMIR Implementation OTC Q.1(d) indicated some 'OTC derivatives' terminology complexities:
"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.
The comparison of the meaning of the term: "OTC derivative" under EMIR on the one hand, and the MiFIR on the other, exhibits some nuances - MiFIR meaning being narrower than the EMIR one (see box).
Under EMIR derivatives are considered to be executed on an OTC basis when they are not traded on, or not subject to the rules of, a regulated market.
In turn, the definition of derivatives executed over-the-counter (OTC) under MiFID II comprises derivatives not traded on, or not subject to the rules of, a regulated market, multilateral trading facility (MTF) or organised trading facility (OTF).
The European derivatives are traded mainly OTC. According to the Risk Assessment On the temporary exclusion of exchange traded derivatives from Articles 35 and 36 of MiFIR of exchange traded derivatives from Articles 35 and 36 of MiFIR, 04 April 2016, ESMA/2016/461 (p. 11) the OTC derivatives market is dominated:
- by interest rate derivatives (IRD) - when measured by outstanding notional amounts (75% of the volumes),
- by foreign-exchange (36%), interest rates (28%), and equity (23%) - when measured by outstanding number of trades.
A significant share of the OTC derivative market will eventually be brought to central clearing as a result of the clearing obligation gradually entering into force in Europe.
The OTC character of the product has several implications in particular as regards specific risks. Among them are:
- a counterparty risk,
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 prescribes the following EMIR reporting format for OTC derivatives (Field 15 of the Table 2 (Common data)):
- where a contract was concluded OTC and the respective instrument is admitted to trading or traded on a trading venue, the MIC code 'XOFF' should be used;
- where a contract was concluded OTC and the respective instrument is not admitted to trading or traded on a trading venue, the prescribed MIC code is 'XXXX'.
Gross notional value of the global over-the-counter derivatives market amounted to US$544trn in the first six months of 2016, a 10% increase over the previous six months but down from US$696trn three years earlier. 62% of OTC derivatives notional was cleared through central counterparties as of June 2016. OTC derivatives market is dominated by interest rate derivatives with gross notionals totaling US$438trn at the end of June 2016 (Derivatives-Swaps notional jumps to US$544trn in first half - BIS).
|Last Updated on Saturday, 11 March 2017 21:51|