ISDA Supports Esma’s Frontloading Proposals

Terry Flanagan

The International Swaps and Derivatives Association said proposals from the European financial regulator about frontloading derivatives before mandatory clearing begins should remove some uncertainty from the market.

Steven Maijoor, chair of the European Securities and Markets Authority, proposed recommendations for frontloading in a letter this week to Commissioner Michel Barnier.

The European Market Infrastructure Regulation will introduce mandatory clearing for certain products in the region. Frontloading covers over-the-counter contracts agreed following the authorization of a central counterparty but that might become subject to clearing before they expire.

Esma authorized the first CCP under Emir on March 18, 2014 but has not yet defined the interest rate swaps or equity derivatives which will have to be cleared. Therefore, since March, European market participants have not known whether certain euro derivatives they have traded will eventually have to be cleared or when clearing will begin.

Maijoor said in the letter: “This lack of legal certainty, hence, introduces new risks and increases compliance costs for counterparties.”

Esma has proposed that frontloading will only apply to contracts once their is legal certainty on which contracts have to be cleared, the date from which clearing begins and which CCPs are available.

A spokesman for ISDA, a trade group for OTC derivatives users, told Markets Media that Esma’s proposed approach should eliminate some uncertainty.

He said: “Esma’s proposal looks to be a practical way of removing some of that uncertainty by clarifying that frontloading for eligible contracts will only apply once participants know which products will be subject to a clearing obligation, and when that mandate will begin.”

Virginie O’Shea, senior analyst at consultancy Aite Group, described the proposals as “semi-good” news.

O’Shea told Markets Media: “The proposals will alleviate some problems but the market is disappointed that Esma did not go the whole hog and define the thresholds for clearing.”

She said it is also possible that the European Commission could reject Esma’s proposals.

The Bank for International Settlements said in a report today that in the second half of last year interest rate derivatives continued to move to non-dealer financial institutions, including CCPs.

The notional amount of interest rate contracts between derivatives dealers fell to $96 trillion at the end of last year from a post-crisis peak of $159 trillion at end of June 2011 according to the BIS.

The BIS report said that central clearing also made further inroads in the credit default swap market last year.

In 2013, CDS contracts with CCPs rose to 26% of all CDS contracts at year-end from 19% at the end of 2012. The report said 37% of more standardized multi-name CDS products are centrally cleared compared to 17% of single-name products.

The shift to central clearing has also led to an increase in netting of CDS, allowing market participants to reduce their counterparty exposure by offsetting contracts with negative market values against contracts with positive market values.

The BIS report said: “The prevalence of netting is greatest for CDS contracts with CCPs and other dealers, where it reduced the ratio of net to gross market values to 9% and 15%, respectively, at end-2013. It is lowest for those with insurance companies (83%) and special purpose vehicles (57%).”

Related articles

  1. CEDX is planning to expand its range of products in 2023, subject to regulatory approvals.

  2. The CFTC regulated derivatives market and clearer was not included in FTX's bankruptcy filing.

  3. Schroders cleared NDF trades across a Asian and Latam currency pairs via Citi.

  4. The derivatives venue owned by FTX wanted to offer products that were not fully collateralized.

  5. Trading Europe From ‘Across the Pond’

    Cboe acquired EuroCCP on 1 July 2020.