Not since the G20 commitment to force the central clearing of standardised OTC derivatives, and the introduction of initial and variation margin requirements for non-centrally cleared derivatives, has the buyside had so much to consider with respect to their swap portfolios.
The publication by The European Commission, on December 7th, of ‘amending regulations as regards measures to mitigate excessive exposures to third-country central counterparties’, was eagerly digested by those with vested interests, giving them much to think about as 2022 drew to a close. The proposal seeks to build up the EU’s central clearing capacity, increasing liquidity and market share, reducing the risks posed to EU financial stability by a third country CCP.
For some time now, market practitioners have called for restraint with respect to any regulatory enforcement, preferring a market-led solution, where clients might always have access to EU & Non-EU CCPs, retaining the choice and competition which is so critical for healthy markets.
Among 35 specific provisions proposed, Article 7a was introduced, requiring financial counterparties and non-financial counterparties which are subject to the clearing obligation to hold active accounts at CCPs established in the EU, within which they should clear a certain portion of their derivatives and report on those activities. ESMA is to establish the specific details of the second account activity as well as the reporting requirements.
Article 7b introduces an additional obligation for EU clearing members and clients to report any clearing undertaken at non-EU CCPs. Again, ESMA will lead the development of the draft regulatory and technical standard in this regard.
Temporary equivalence is in place which allows for continued access to third country CCPs until June 2025. That date, however, should not be interpreted as a target. The rhetoric seems to be that, between now and then, the European Commission expects to see a market-led rebalance of cleared derivative flows to an EU domiciled CCP. If ‘sufficient’ progress is made, and market share does grow to a satisfactory level within the EU, further enforcement, such as a full relocation policy, may be less likely.
Addressing the problem
Financial counterparties and non-financial counterparties, subject to the clearing obligation, within the EU are expected to reduce their exposures to third country CCPs for the following: OTC interest rate derivatives denominated in Zloty and Euros, as well as Credit Default Swaps and Short-Term Interest Rate futures in Euros.
Overall, firms now have a difficult path to navigate, with analysis required on current risk exposures across multiple products, multiple CCPs and a myriad of counterparty relationships. You may see this as an opportunity to optimize your derivative strategy through the blending of bilateral swaps into the cleared environment, or by reallocation of risk across clearing brokers. But there are many considerations – and the sooner that analysis begins, the sooner you can arrive at a target strategy.
How can we help?
As specialists in asset management, experts in clearing risk and regulation and as part of Davies, we combine data analysis, derivatives expertise and project execution capabilities in a model which reduces gross risk exposures, margin requirements and the associated funding costs, leading to potentially significant savings over the lifetime of the derivative portfolios.
To find out more about how we can assist you with any aspect of the points raised above, or your wider requirements, please contact us.