Friday, July 19, 2013 10:48:14 AM

Less-liquid contracts pose challenge for EMIR

The European Securities and Markets Authority (ESMA) will face difficulties in setting rules for less-liquid OTC derivatives, experts have warned, as it calls for industry input on mandated clearing rules under the European market infrastructure regulation (EMIR). 

Anthony Belchambers, chief executive of Europe-focused derivatives trade body the Futures and Options Association, told the Clearing Obligation under EMIR document was broadly positive, but establishing rules for instruments which experience fluctuations in liquidity would be difficult.

"Central clearing may turn some contracts into uneconomic instruments to use, so ESMA must balance policy initiatives with economic consequences for end-users," he said.

In the document, ESMA explains it will isolate which contracts will be subject to central clearing by grouping characteristics of derivatives across asset classes. This 'bottom-up' approach will reduce negative impacts on the market compared to a more prescriptive approach. This would cover OTC derivatives products related to interest rates, credit, equities, FX and commodities - for which clearing through central counterparties (CCPs) is already common.

"The advantage of this approach is that it will not be possible that a contract subject to the clearing obligation does not have a CCP to clear it," the document read.

However Belchambers believes regulators must be careful to gauge the impact of rules on CCPs, which could see further consolidation amongst clearing houses and possible changes in how market participants use the entities.

"The economics of clearing are shifting," Belchambers added. "The regulators need to be careful not to push through certain contracts for central clearing because they could exacerbate risk to the CCP. Clearing members may also look at how this process changes a CCPs risk profile," he said.

Alex McDonald, chairman of the Wholesale Markets Brokers' Association, also believes ESMA may encounter difficulties in setting appropriate rules for less-liquid OTC derivatives.

"Deciding on technical standards for the less-liquid instruments will be more of a challenge as the process continues," he told

"The ESMA discussion paper on central clearing of OTC derivatives is broadly what was expected and there is a clear focus on mandating instruments widely cleared by market participants, such as credit default swap indices and interest rate swaps."

McDonald added that ESMA's approach largely mirrored that of the US regulator the Commodity Futures Trading Commission, which has centered its initial efforts to implementing mandating central clearing of OTC derivatives on IRS and CDS products.

Market participants have until 12 September to respond to the discussion paper, and ESMA has indicated the final rules will come into force from July 2015. In March, the Authority opened applications of authorisation for European CCPs and clearing houses from other regions seeking to operate in Europe.

Under the proposed timeline, ESMA will attempt to submit draft rules for central clearing by March 2014.

Earlier this week, ESMA also released a consultation paper on rules for non-European Union counterparties in certain cases, to reduce the ability of such entities to avoid rules under EMIR.

Richard Henderson +1 212 217 6916