Buy Side Responds to Esma on Clearing Swaps

Terry Flanagan

Asset management firms have welcomed the introduction of mandatory clearing for over-the-counter derivatives in Europe but expressed concerns on the lack of clarity for exemptions for pensions, lack of international harmonisation and frontloading requirements.

The European Securities and Markets Authority issued a consultation paper on clearing interest swaps and has published responses from the financial industry on its website.

State Street, the US fund manager, said in its response that it welcomed mandatory clearing and proposed a phased-in approach to allow a smooth transition and avoid market disruptions.

However in relation interest rate swaps, State Street said it had concerns over the lack of clarity over the exemptions for pension schemes.

The asset manager said: “In light of the proposed timeframe for the frontloading requirements, State Street would urge Esma and the European Insurance and Occupational Pensions Authority to provide such additional clarification as soon as possible to avoid any negative unintended consequences.”

Frontloading covers existing over-the-counter contracts which might become subject to mandatory clearing before they mature. State Street warned that if frontloading begins before the pension exemption is implemented, uncertainty will affect valuations, the use of collateral, and result in significant costs which will lower returns for pension beneficiaries.

The Investment Management Association, which represents the UK-based investment management industry, also said that in its response that its members were concerned about the uncertainty surrounding the pension exemption.

In addition the IMA said its members preferred the option of removing the frontloading obligation for category two counterparties and reducing the phase-in period for new trades to be cleared from 18 to 12 months.

“This will result in new OTC contracts entering the cleared environment earlier than originally planned, and will reduce the frontloading burden on firms and the pricing uncertainty created in the market,” the IMA added.

The IMA also pushed for internationally consistent clearing requirements and cited Overnight Index Swaps as one example.

“In the US, Dodd-Frank does not require Overnight Index Swaps over two years to be cleared, yet in the draft regulatory technical standards, Esma proposes that OIS up to three years will be subject to mandatory clearing,” added the IMA. “We suggest that Esma reduce this to two years, in the interest of global harmonisation.”

The Norges Bank Investment Management, which manages the world’s largest sovereign wealth fund, the Norwegian Government Pension Fund Global, agreed that co-operation between the international regulators is crucial to prevent regulatory arbitrage.

“Furthermore regulators should share reporting data among themselves in order to be able to fully understand systemic risk in the global swaps market,” said the NBIM.

The Norwegian manager said it supported Esma’s efforts to regulate OTC derivatives and that it intended to centrally clear interest rate derivatives on a voluntary basis in order to reduce its counterparty risk.

The NBIM added that mandatory clearing should focus on asset classes which are already being cleared by at least two CCPs in sufficient volume, such as interest rate swaps and certain types of index credit default swaps.

“We also believe that the imposition of a clearing obligation should only take place when there is certainty as to the capacity and capability of the relevant CCPs to handle expected volumes and effectively manage default and resolution scenarios,” the NBIM said.

The Norwegian manager also warned that as clearing houses become more important they could pose a systemic risk.

The Norwegian response said: “We think particular emphasis needs to be put on collateral requirements, as collateral is a critical component in determining the creditworthiness of a clearing house.”

The Asset Management Group of the US Securities Industry and Financial Markets Association welcomed the phased-in implementation of mandatory clearing in Europe but said it is crucial that Esma authorises central clearers from other jurisdictions before the rules come into effect.

“Early equivalence decisions are likely to be even more important to the extent that frontloading applies to category two counterparties, as category one dealers transacting with a category two counterparty subject to frontloading are likely to favour entering into cleared rather than uncleared contracts in advance of the date on which the clearing obligation under Emir actually takes effect,” added Sifma.

Sifma said that without harmonisation cross-border OTC derivatives contracts could become equally subject to the mandatory clearing requirements under both the Dodd Frank Act and Emir.

“In the absence of an equivalence decision therefore, it is not clear how such an entity should comply with these parallel, and potentially conflicting, obligations, as an OTC derivative contract can obviously only be cleared once,” added Sifma.

Featured image via Flickr/Jean-Etienne Minh-Duy Poirrier under creative commons

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