Annexes to COM(2021)172 - Whether trades that directly result from post-trade risk reduction services should be exempted from the clearing obligation for OTC derivatives under EMIR - Main contents
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This page contains a limited version of this dossier in the EU Monitor.
| dossier | COM(2021)172 - Whether trades that directly result from post-trade risk reduction services should be exempted from the clearing obligation ... |
|---|---|
| document | COM(2021)172  |
| date | April 12, 2021 |
b.Potential for circumvention of the clearing obligation
Article 85(3)(c) of EMIR requires that the European Commission's report considers whether an exemption from the clearing obligation for PTRR services has a potential for circumvention of the clearing obligation.
On the one hand, ESMA points out that PTRR services currently avoid the clearing obligation by ensuring that the resulting trades do not belong to a category of OTC derivative subject to the clearing obligation, e.g. more complicated swaptions instead of plain vanilla derivatives. Should such derivatives originating from PTRR services be exempt from the clearing obligation in the future, counterparties engaged in PTRR services could use these simpler and more standardised instruments. ESMA considers it unlikely that such an exemption would lead to the circumvention of the clearing obligation, as such derivatives would have never been concluded without the exemption. Only the exemption would make it possible to use them for PTRR purposes in the non-centrally cleared space. ESMA views such derivative transactions as merely "administrative". They would not be entered into for any other reason. According to ESMA, an exemption would not incentivise market participants to use this technique as a way to avoid central clearing as it would not affect OTC derivatives under the clearing obligation resulting from ordinary trading activities.
On the other hand, some stakeholders note that an exemption to the clearing obligation would open up significant possibilities for regulatory arbitrage and ‘clever’ trading to extract OTC derivatives currently in cleared portfolios and to bring them into the uncleared space. This could act as an incentive for the circumvention of the clearing obligation leading to more rather than less risk.
To avoid any such circumvention of the clearing obligation, ESMA recommends developing conditions for any exemption from the clearing obligation. Such conditions could limit any exemption to certain OTC derivatives, e.g. legacy trades, or to certain PTRR services. ESMA also suggests introducing some requirements for PTRR services, e.g. they should be market risk neutral, reduce the bilateral risk in the portfolio into which it is booked, and be carried out by an independent service provider.
Although the requirements for and conditions to the exemption from the clearing obligation that ESMA proposes might limit the possibilities of using such an exemption to circumvent the clearing obligation, further analysis is needed. In particular, the idea of mixed (centrally cleared and uncleared) OTC derivatives portfolios being included in portfolio rebalancing services benefitting from the exemption from the clearing obligation, and to combine PTRR services in the uncleared space with transactions to shift risk to central clearing (see end of Section 3) would alter the relationship between the centrally cleared and the uncleared space, and the fact that different risk mitigation tools should be used in the centrally cleared and the uncleared space.
Further analysis of the possible liquidity shifts from the centrally cleared to the uncleared space should also be considered.
c.Potential disincentive to central clearing
The market is split as to the potential disincentive to central clearing that may arise from an exemption from the clearing obligation for trades resulting from PTRR services. ESMA concludes therefore that while there is no evidence that there would be a risk of disincentive of the clearing obligation this should be monitored carefully in order to ensure that if any risk were to materialise it could be addressed by further regulation and/or supervisory measures.
Should the exemption from the clearing obligation represent a cheaper option in the future in terms of capital and margin costs to hedge trades in the bilateral space, this could lead to a disincentive to central clearing. In such circumstances, to clear bilateral only could be more economical viable in terms of capital and margin costs, the larger the netting set.
Voluntary central clearing shows that this potential disincentive does not fully fall away: It is quite evident that counterparties that could centrally clear an OTC derivative but choose not to do so, make that choice because bilateral clearing is economically reasonable for them. Moreover, a possible reduction of liquidity would disincentivise participation in central clearing.
The impact of PTRR services in terms of a possible disincentive to clearing is inconclusive. Taking into account divergent stakeholder views as well as ESMA’s report, further analysis by ESMA would be beneficial, in particular on the impact on incentives to central clearing which are strengthened where there is more liquidity in the centrally cleared space.
5.Conclusion
In EMIR, the co-legislators opted for central clearing as a key element of the G20 commitments which should be the primary risk mitigation tool for plain vanilla OTC derivatives under the clearing obligation. Other, not as far reaching risk mitigation techniques should be used with regard to other OTC derivatives not falling under the clearing obligation. Both, central clearing and PTRR services thrive in their respective spaces. Generally, certain OTC derivatives should only be exempted from the clearing obligation where the risks of granting such an exemption are smaller than the risks of keeping the situation as it is today.
ESMA, in cooperation with the ESRB, has undertaken an extensive and thorough analysis of PTRR services. Nevertheless, there remain important open questions. In particular, some of the aspects of the report require further quantitative assessment and analysis in order for the Commission to be able to make a more informed decision on any potential proposal for legislative change.
In particular, the following issues need further consideration:
-The definition of PTRR services, e.g. how different types of PTRR could be defined more concretely;
-The possible interlinkages between PTRR services and the impact of their combined use on the aspects raised in this report;
-The materiality of the risk of the circumvention of the clearing obligation, especially possible market practices that could be used to conduct such a circumvention;
-Possible conditions limiting the risk of such misuse of a possible exemption from the clearing obligation;
-The incentives to centrally clear taking into account a possible exemption from the clearing obligation;
-Evaluation of potential liquidity shifts from centrally cleared to uncleared space.
Further work on the abovementioned issues, in particular on the definitions of PTRR services and to collect more quantitative evidence, would enable a more comprehensive and well rounded assessment of the issues, which could feed into the general EMIR assessment report, which should be submitted to the European Parliament and the Council by 18 June 2024 12 .
(1)
OJ L 201, 27.7.2012, p. 1.
(2)
OJ L 142, 28.5.2019, p. 42.
(3)
ESMA, Report to the European Commission, Report on post trade risk reduction services with regards to the clearing obligation (EMIR Article 85(3a)), 10 November 2020, ESMA70-156-3351, ESMA70-156-3351 Final Report PTRR Services - Article 85(3a) of EMIR (europa.eu) .
(4)
ESRB, ESRB opinion on ESMA's report on post trade risk reduction services with regards to the clearing obligation (EMIR Article 85(3a)), 12 June 2020, ESRB opinion on ESMAs report on post trade risk reduction services with regards to the clearing obligation (europa.eu) .
(5)
ESMA, Consultation Paper, Report on post trade risk reduction services with regards to the clearing obligation (EMIR Article 85(3a)), 26 March 2020, ESMA70-151-2852, esma70-151-2852_consultation_report_ptrr_services_-_article_853a_of_emir.pdf (europa.eu) .
(6)
Article 2(1)(47) of Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Regulation (EU) No 648/2012, OJ L 173, 12.6.2014, p. 84–148
(7)
ESMA, Report to the European Commission, Report on post trade risk reduction services with regards to the clearing obligation (EMIR Article 85(3a)), 10 November 2020, ESMA70-156-3351, ESMA70-156-3351 Final Report PTRR Services - Article 85(3a) of EMIR (europa.eu) , chapter 8.1, para. 332.
(8)
ESMA, Report to the European Commission, Report on post trade risk reduction services with regards to the clearing obligation (EMIR Article 85(3a)), 10 November 2020, ESMA70-156-3351, ESMA70-156-3351 Final Report PTRR Services - Article 85(3a) of EMIR (europa.eu) , chapter 8.2, para. 333 to 338.
(9)
ESMA, Report to the European Commission, Report on post trade risk reduction services with regards to the clearing obligation (EMIR Article 85(3a)), 10 November 2020, ESMA70-156-3351, ESMA70-156-3351 Final Report PTRR Services - Article 85(3a) of EMIR (europa.eu) , chapter 8.3, para. 339 to 347.
(10)
FR09/2015, 28 January 2015, p. 13, FR01/2015 Risk Mitigation Standards for Non-centrally Cleared OTC Derivatives (iosco.org) .
(11)
Commission Delegated Regulation (EU) No 149/2013 of 19 December 2012 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on indirect clearing arrangements, the clearing obligation, the public register, access to a trading venue, non-financial counterparties, and risk mitigation techniques for OTC derivatives contracts not cleared by a CCP, OJ L 052, 23.2.2013, p. 11.
(12)
Article 85(1) of Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories