On 1 October 2014, ESMA published two papers on draft Regulatory Technical Standards (RTS) for the clearing of OTC derivatives under the European Market Infrastructure Regulation (648/2012) (EMIR):
- A final report (the Final Report) setting out the draft RTS on the clearing obligation for OTC interest rate derivatives (IRS), which was submitted to the European Commission.
- A consultation paper (the Consultation Paper) on the clearing obligation for non-deliverable FX forwards (NDFs) with a consultation draft of the RTS for clearing NDFs (NDF RTS). This consultation closes 6 November 2014.
The Final Report and the Consultation Paper both seek to limit the range of derivatives subject to the clearing obligation by reference to the available clearing capacity for those derivatives. They do so in a way which will come as a relief to those concerned about how the clearing obligation could affect structured or bespoke derivatives.
The Basic Rule The Final Report and the Consultation Paper provide that OTC derivatives must be cleared where they (a) have the key characteristics referred to below and (b) are accepted for clearing by an authorised CCP or, in the case of IRS, a recognised CCP.1 (This approach is similar to that adopted in the United States.)
Snapshot at CCP Authorisation Date Both the IRS RTS and the NDF RTS indicate that the clearing obligation applies only to these derivatives where they are accepted for clearing by a CCP at the time the CCP is authorised. So if, following authorisation, an authorised CCP begins to offer a new class of IRS or NDF derivatives for clearing, that new class will not be subject to the clearing obligation under these RTSs. Another RTS would be needed to extend the clearing obligation to this new class.2
Interest Rate Derivatives – the 7 characteristics
The key characteristics are specified in detail in the Final Report under the following headings:
- Product type (currently fixed-to-float interest rate swaps (plain vanilla IRS), float-to-float swaps (basis swaps), forward rate agreements, and overnight index swaps)
- Reference index (several specified)
- Settlement currency (several specified)
- Maturity (various tenors specified)
- Settlement currency type – (i.e. whether on a single or multiple currency basis)
- Optionality – (i.e. the existence of embedded optionality)
- Notional type – (i.e. whether constant, variable or conditional)
NDFs – the 5 characteristics
The key characteristics are specified in detail in the Consultation Paper under the following headings:
- Product type (currently non-deliverable FX forwards)
- Currency pair (various pairs specified)
- Settlement currency (currently US$ only)
- Settlement type (currently cash-settled only)
- Maturity (3D to 2Y)
Securitisations and Structured Derivatives EMIR does not specifically address securitisation swaps or structured derivatives. There is no specific exemption taking them out of the clearing obligation as a matter of principle. However, it is unlikely that securitisation swaps or structured derivatives would become subject to the clearing obligation since their features are unlikely to match those accepted for clearing by any authorised or recognised CCPs. They are likely not to be sufficiently standardised or liquid.
Also, since the notional amounts for securitisation swaps are usually conditional, they would not meet all of the seven key characteristics for IRS.
Covered Bonds excluded Each draft RTS also provides that contracts associated with covered bonds otherwise meeting all the requirements of the relevant draft RTS are nevertheless not caught by the clearing obligation.
Territorial scope The Final Report indicates that the clearing obligation falls directly on EU counterparties only. Where an IRS subject to the clearing obligation is entered into between:
- an EU “financial counterparty” (FC) or “non-financial counterparty over the clearing threshold” (NFC+) on the one hand, and
- a non-EU counterparty which would be an FC or NFC+ if it were a European entity (TC+),on the other, the clearing obligation would fall on the FC or NFC+ and not directly on the TC+.
Phase-in by categories of person The table below sets out the categories of counterparties subject to the clearing obligation, the date from which it will apply, and some aspect of the approach taken to frontloading, which is largely intended to do away with frontloading as a practical consideration. (Contracts between parties from different categories are subject to clearing on the later of the two dates.)
Can circumstances change the timings? One significant issue not dealt with by either of the RTSs is the impact of MiFID2/MiFIR on these timings. Some counterparties currently in category 4 may be moved to category 2 or 3 if they become FCs as a result of MiFID2/MiFIR coming into force. This would mean that clearing obligations could be accelerated for these counterparties on the date MiFID2/MiFIR come into force (1 Jan 2017). Category 4 members would otherwise not be subject to clearing obligations for these classes of derivatives until 2018.
Similar issues could arise, on an ad hoc basis, if counterparties become clearing members of relevant CCPs or extend the scope of their clearing abilities to include relevant classes of derivatives.
- Authorised CCPs are EU-based CCPs which are authorised under EMIR by their relevant national regulator to provide clearing services in the EU. As of 16 September 2014, 13 CCPs have been authorised. Recognised CCPs are CCPs from non-EU countries that are deemed by the Commission, have an equivalent regulatory regime to that imposed by EMIR, and are recognised by ESMA to provide clearing services in the EU. As the Commission has not yet made any equivalency decisions, no third-country CCPs have been recognised, although 38 have applied for recognition.
- The language used in both RTSs on this point refers only the time of authorisation of authorised CCPs. There is no reference to the date of recognition for recognised CCPs. This may be due to the fact that the Commission has not yet recognised any third-country CCP.
- Once a counterparty has determined their category for one class of products (for example, IRS), they will be in the same category for the other OTC derivative contracts (such as NDFs and credit default swaps).
- On the assumption that the IRS RTS enters into force during February 2015, the relevant months for both RTSs will be November 2014, December 2014 and January 2015. The calculation of a group’s aggregated month-end average notional amount of non-centrally cleared derivatives includes all of the group’s non-centrally cleared derivatives, particularly foreign exchange forwards, swaps and currency swaps.
- ESMA has decided that the three-year phase-in period set out in the IRS RTS should be shortened progressively for each subsequent RTS. As such, the NDF RTS suggests a phase-in period of 33 months on the basis there will be three months between the delivery to the Commission of the IRS RTS and the delivery to the Commission of the NDF RTS.
Client Alert 2014-273