ISDA, EBF, ICMA and ISLA Publish Post-trade Whitepaper
The International Swaps and Derivatives Association, Inc. (ISDA), the European Banking Federation (EBF), International Capital Market Association (ICMA) and the International Securities Lending Association (ISLA) have today published a whitepaper on the benefits of post-trade risk reduction services as a crucial risk management tool.
Post-trade risk reduction services like compression and counterparty rebalancing play an increasingly important role in reducing risks in derivatives markets. Compression, for example, results in offsetting trades between multiple parties being torn up, which reduces the size of gross derivatives exposures, in turn reducing systemic risk.
These risk-mitigating benefits are recognized in the European Union (EU) under the revised Markets in Financial Instruments Directive and its associated regulation (MIFID II/MIFIR), which exempt post-trade risk reduction administrative transactions from the trading obligation. There is, however, currently no exemption from the clearing obligation in the EU for these transactions. The failure to recognize these strictly non-trading and market risk neutral administrative transactions within the European Market Infrastructure Regulation (EMIR) limits systemic risk reduction in derivatives markets.
In the paper, ISDA, the EBF, ICMA and ISLA recommend that EMIR be amended as part of the Regulatory Fitness and Performance Program, or REFIT, to exempt transactions resulting from post-trade risk reduction services from the clearing obligation, or to empower the European Securities and Markets Authority to do so.
“Post-trade risk reduction has become an essential risk-management tool for the derivatives market, resulting in hundreds of trillions of euros in derivatives risks being removed. An exemption from the EMIR clearing obligation for transactions resulting from post-trade risk reduction would help further reduce systemic risk,” said Roger Cogan, Head of European Public Policy at ISDA.
“Collateral in the form of margin is an essential risk management tool, but rather than over rely on this mechanism, it makes sense to better facilitate post-trade risk reduction and so reduce aggregate exposure levels,” said ICMA Chief Executive Martin Scheck.
“Recognizing the risk reduction benefits of compression – for example, reducing counterparty risk and therefore systemic risk – is critical when considering amendments to EMIR,” said Mark Hutchings, Chief Operating Officer at ISLA. “For securities lending, post-trade risk reduction like compression will bring with it efficiencies such as less collateral being called, which will ultimately improve collateral liquidity and reduce collateral costs.”
The Associations make the following recommendations on conditions for satisfying any exemption.
- They should be market risk neutral: They are designed to not change the directional market risk of the portfolios concerned, but rather reduce counterparty, operational and systemic risk in respect of existing derivatives transactions.
- They should be non-price forming: While they may involve a new legal transaction (rather than a trading transaction) in order to achieve the identified risk reduction result, participants are not able to post bids or offers, no price negotiation takes place and market risk neutrality means transactions are recorded away from market prices on stale curves.
- They should address second-order portfolio risks: They do not offer a vehicle for taking market positions or entering into trading transactions. Their purpose is the reduction of operational, counterparty and systemic risk.
- Single multilateral compound transaction: The risk-reduction cycles are binding on an all or nothing basis across all cycle participants and the transaction components are executed as a single compound bulk legal transaction.
Phase 5 of the uncleared margin rules (UMR) took effect from September 2021.
Temporary equivalence is set to expire on June 30 2022.
IRS trading volumes have fragmented without an equivalence agreement.
Phase 5 of the uncleared margin rules came into effect on 1 September.
Triparty repos can be executed across U.S. Treasury securities to central clearing.