European Regulator Proposes OTC Derivatives Rules

Terry Flanagan

A European regulator has proposed standards for implementing derivatives reforms, including central clearing and trade repositories.

The draft standards, issued by the European Securities and Markets Authority (Esma), the pan-European regulator, are intended to implement European Market Infrastructure Regulation (Emir), which was finalized during trialogue discussions earlier this year among the European parliament, European Commission and the Council of the European Union.

Emir introduces provisions to improve transparency and reduce risks associated with the OTC derivatives market, and establishes common rules for central counterparties (CCPs) and trade repositories.

Common rules are required in the case of CCPs in view of the shift from a bilateral to a central process for OTC derivatives, and in the case of trade repositories because of the increase in information that needs to be reported.

“Unlike mandatory clearing or electronic trading, the concept of trade repositories, or swap data repositories (SDRs) as they are known in the United States, and the way they are used to provide market transparency is well entrenched in the thinking of market participants now, and is largely reflected in existing or re-engineered market practices agreed in industry forums,” said Ryan Baccus, vice-president of Sapient Global Markets, a capital markets consultancy.

Separately, the European Banking Authority (EBA), an agency of the European Commission, launched this month an open consultation on draft standards on the capital requirements for CCPs.

Emir requires CCPs to collect margins, to maintain a pre-funded default fund and to maintain dedicated own resources to cover their losses upon the default of one of their clearing members. The draft regulatory technical standards developed by the EBA are intended to specify these additional capital requirements.

Concerns remain about the conditions under which access by non-EU authorities to data held in EU trade repositories would be possible. Emir provides for two main mechanisms for access. The first, available to non-EU countries that have a trade repository established in their jurisdiction, would require the signing of an international agreement regarding mutual access to trade repository data and the exchange of information. The second, applicable to non-EU countries without a trade repository, would require a co-operation agreement with Esma.

The details of such agreements, including the terms on which they would be made and the process for concluding them, are not yet clear, and a number of non-EU countries are concerned that the first mechanism may be excessively time-consuming and formal to negotiate, and would risk delaying data access for several years.

“From the perspective of the SDR construct, the only real uncertainty, aside from associated pending rules and clarifications, is how the regulators intend to utilize the mountains of data coming their way to fulfill their supervisory obligations,” said Baccus.

One of the stickiest issues has been the extent to which derivatives contracts involving third countries (i.e., non-EU countries) would be subject to mandatory clearing under Emir.

“While Dodd-Frank, Emir and many other jurisdictions’ derivatives regulations are quite broad and touch on areas from execution through to reporting, the requirement to centrally clear derivative transactions will have the most significant impact on the industry, as that mandate carries with it significant intended and unintended consequences,” said Ted Leveroni, executive director of derivatives strategy at post-trade provider Omgeo.

In ascertaining which contracts should be eligible for clearing, Esma is soliciting comment on which contracts are considered to have a “direct, substantial and foreseeable effect” within the EU, and how Esma should prevent evasion of the clearing obligation for contracts entered into or between counterparties located in a third country.

“The G20 declaration is not prescriptive in terms of how you deliver it,” said Baccus. “It states the need for more standardization, transparency and clearing, but it’s up to each jurisdiction to come up with its own legislation.”

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