The phase-in for central counterparty clearing (CCP) for certain Over-the-Counter (OTC) derivative contracts began in 21 June 2016 for certain contracts, with many more soon to follow, until all in-scope contracts are subject to the obligations by 9 August 2019. The European Market Infrastructure Regulation (EMIR) requires certain classes of OTC derivative contracts to be centrally cleared and, over the next few years, this obligation will go live for the different categories caught by this regulation, as well as frontloading obligations for some classes.
The aim of the clearing obligations in EMIR is to mitigate risk, both systemically and for the counterparties, by replacing a system whereby the two counterparties have a single derivatives contract, with two separate contracts that are engaged in with the central counterparty, which takes on an intermediary role between the two. If one or more of the transaction’s parties is established in the European Economic Area (EEA) then, for any combination of Financial Counterparty (FC), such as banks, asset managers, insurers; and Non-Financial Counterparty (NFC), the clearing obligation would apply.
The clearing procedure began back in Q1 2014, after the first CCPs were ‘authorised’ (EU) or ‘recognised’ (non-EU). The European Securities and Markets Authority (ESMA) started the process of analysing the asset classes, including interest rate, credit, equity and FX OTC derivatives, in an attempt to identify which classes ought to be subject to clearing obligations. The time discrepancy between the authorisation of CCPs and the identification of the affected classes has led to the frontloading obligation. This is a type of retrospective clearing obligation: certain OTC derivative contracts that were entered into within a prescribed period before the entry into force of the obligation must be centrally cleared. This does not apply across the board, affecting only the first two identified categories detailed below.
The categories are as follows:
Category 1: Counterparties, whether they be FCs or NFC+s, which have membership to at least one CCP that is authorised to clear any class of OTC derivative contracts that are subject to the clearing obligation, provided their membership allows the clearing of the relevant derivative class.
Category 2: FCs not included in the previous category and AIFs (Alternative Investment Funds) that are NFC+s, meaning that they must also pass the EUR 8 billion threshold for their aggregate average gross notional outstanding in OTC derivative contracts over the three months following the publication of the RTS.
Category 3: Those that missed entry into category 2 by being below the EUR 8 billion threshold.
Category 4: All other NFC that are not captured by the other categories.
So far, ESMA has assessed several classes of OTC derivative contracts, and has published RTS for Interest Rate Swaps (IRS), which include Basis, Fixed-to-Float, Forward Rate Agreements (FRA) and Overnight Indexed Swaps (IOS) for the G4 currencies (EUR, GBP, JPY, USD) and also NOK, PLN, and SEK. A RTS has also been published for Index Credit Default Swaps (Index CDS). As yet, there have been no proposed RTS for FX, including non-deliverable forwards (NDF), nor for equities, including Lookalike/Flexible equity derivatives and Contract for Difference (CFD) and so, for the moment, they will not be subject to clearing or frontloading obligations.
The phase-in timeline for the clearing and frontloading obligations is as follows:
|Class||Category 1||Category 2||Category 3||Category 4|
|For IRS in G4 currencies||21-Jun-16||21-Dec-16||21-Jun-17||21-Dec-18|
|For Index CDS||09-Feb-17||09-Aug-17||09-Feb-18||09-May-19|
|For IRS in NOK, PLN, SEK||09-Feb-17||09-Aug-17||09-Feb-18||09-Aug-19|
The frontloading obligations for Category 1 are for IRS derivatives that have been concluded or novated in the four months before the start date of the clearing obligation. For Category 2, this is a period of seven months before the start date of the clearing obligation.
There is an exemption from the clearing obligations for OTC derivative ‘intragroup transactions’ if, either both counterparties are established in the EEA and there has been no objection, or if one counterparty is within the EEA and the other is in a third country, and the EEA counterparty has been authorised by its supervisor to apply for the exemption.
Under EMIR, OTC derivatives that are not centrally cleared are required to apply risk mitigation techniques. These include timely confirmation, portfolio reconciliation and compression and dispute resolution procedures.
Deadlines are fast approaching for several classes, and firms will need to have plans in place in order to comply, by identifying where they will be affected. Getting clearing arrangements in place will be critical. Ultimately, the success of the clearing obligations will only be accurately assessed a few years down the line, as more categories begin to comply.