Negotiators representing the European Commission, European Parliament and EU Council of Ministers recently reached agreement on the European Markets Infrastructure Regulation (EMIR), which sets out new European rules on clearing, bilateral risk mitigation and trade repository reporting. It is expected that the agreement will be endorsed by the European Parliament during the week of March 12-16; the Council of Ministers will also endorse it that month.
EMIR represents another milestone toward reaching the objective, set by the G20, of increasing transparency and reducing risk in the over-the-counter (OTC) derivatives markets. It aims to achieve risk reduction by requiring financial firms (as well as non-financial, subject to a threshold) to clear OTC derivatives “deemed” eligible (i.e., standardized) through CCPs, while it requires non-eligible OTC derivatives to be risk-managed under rules set out in the Regulation. It aims to achieve increased transparency by requiring the reporting of all derivatives (OTC or otherwise) to trade repositories (TRs).
The Regulation contains exemptions from the clearing requirements for non-financial companies, sovereigns, multi-lateral development banks, and other public sector entities that are fully guaranteed by their respective states. It also exempts pension funds for the next three to five years – pending creation, it is hoped, of suitable clearing solutions for such funds. Exempted from the clearing requirement are also intragroup transactions which meet certain requirements. Finally, EMIR also regulates CCPs and TRs, specifying the rules governing CCPs (e.g. in relation to risk management, capitalization, collateral and margin).
Many aspects of the legislation remain to be further defined and refined by ESMA and/or the various national regulatory authorities. Although the law is effective once it is published in the Official Journal, from a practical point of view, much of the detail will not be clear until ESMA (with the assistance of the other ESAs, or European Supervisory Authorities) thrashes out the details and the European Commission adopts relevant technical standards. The ESAs are expected to finish their work by end-September, with a further three months for the European Commission to approve them. At that point, the technical standards will come into force.
It’s clear that, given the uncertainty as to how exactly these standards will affect regulated firms, ESMA will need to deploy the scope it has been given in the main EMIR regulation to phase-in some aspects of the legislation (e.g. for clearing) for categories of counterparty.
Following closely on EMIR’s announcement, ESMA has just come out with a 75-page discussion paper on draft technical standards. The topics to be clarified are organized around 83 questions and cover a wide variety of issues. Important questions, such as which OTC products are “deemed” eligible for clearing, remain open. Similarly, questions as to where such transactions will be cleared and as to the requirements of CCP authorization (and a lot of the detailed but important aspects of CCP governance, capitalization, and margining) also remain to be clarified. ESMA expects market participants to submit comments by March 19th.
ISDA has repeatedly stated its support for resilient and efficient markets. Regulatory infrastructure initiatives, such as clearing, contribute to these objectives. Moreover, ISDA supports a prudently managed transition to robust CCPs and, as such, it supports EMIR. It also supports the authority delegated to ESMA. Equally, though, we have expressed our concerns ‒ in a joint letter to EU Commissioner Barnier with other relevant trade associations ‒ that not enough time is being allowed for the proper consideration of these important issues.
Above all, we are concerned with the fact that large amounts of risk are in the process of being transferred to the CCPs without an adequate understanding of the sequencing involved, potential bifurcation of risk, and unwanted concentrations of risk in the newly formed (and untested) CCPs.
We are also concerned that parallel efforts in the US and European fronts may lead to an uneven playing field, giving rising to unwanted regulatory arbitrage, despite the stated objective by G20 to take action at the national and international level to raise standards together and “implement standards consistently in a way that ensures a level playing field and avoids fragmentation of markets, protectionism, and regulatory arbitrage.”
As we have highlighted in our letter to Commissioner Barnier, Danish Finance Minister Corydon and ECON Committee Chairman Bowles, it is essential that, as they approach critical rule-making mandates over the coming months and years, the ESAs are provided with the time and opportunity to succeed.