ESMA pressed to apply broad OTC derivatives definition
Market participants have advised
Europe’s securities watchdog to keep the specifications for deciding which OTC
derivatives can be cleared as broad as possible to avoid circumvention of new
The issue of swap
standardisation is a key facet of new rules that will transform bilateral OTC
derivatives trading into an exchange-traded, centrally-cleared market.
Comments on how products
should be standardised were part of responses to a consultation by the European
Securities and Markets Authority (ESMA), which is in the process of devising
technical standards to accompany the new rules.
Eurex Clearing, the central
counterparty (CCP) owned by Deutsche Börse, thought a reasonably broad
definition for deciding which products can be standardised should be applied.
“An excessively narrow
description of legal frameworks and operational processes would encourage an
evasion of the clearing obligation,” wrote Eurex in its reply to ESMA.
The European Association of
Clearing Houses, the trade body which counts 23 CCPs as members, added “the risks of avoidance of the clearing obligation are more apparent than
the risks of a CCP not being able to clear a particular class of standardised
Under EMIR, ESMA will
facilitate a ‘bottom-up’ approach in deciding which derivatives are centrally
cleared. The watchdog will first analyse the types of derivatives that can be
cleared using the approach determined by the technical standards. In its
consultation paper, ESMA said this would be determined by factors including
whether the margins
would be proportionate to the risk that the clearing obligation intends to
mitigate, the historical stability of the liquidity through time, and whether
there is enough relevant, accessible information on which to base prices for
contracts. Central counterparties will then be required to
apply to ESMA, via their home regulator, stipulating the classes of derivatives
they wish to clear.
Inter-dealer broker ICAP added ESMA should also consider the potential for significant
variation in economic terms within a particular class of derivatives.
“ESMA should consider
additional factors such as the number of instruments per class of derivative,
the trading interest per instrument, the value at risk, and the level of
volatility,” wrote ICAP. “ESMA may also wish to take into account particular
characteristics, such as whether the transaction is an outright or a spread
trade, as well as the potential for liquidity in certain instruments to
Other market participants
stressed the need for derivatives standardisation to be considered in line with
the trading venue categories for OTC derivatives that are defined in MiFID II.
The latest version of the directive introduces the organised trading facility
(OTF), a venue class giving operators discretion over access. A
greater number of multilateral trading facilities (MTF) and systematic internalisers
are also expected to emerge as the new derivatives rules reach the
“Liquidity is probably the most important and difficult to predict,” wrote
Deutsche Bank. “It is important to consider how and where products are traded
and whether this would be robust in a default situation. The OTF/MTF execution
mandate as currently proposed will require a separate decision on products being ‘sufficiently
liquid’, but clearable products will also overlap with the systematic
internalisation regime which will impact liquidity and ability of participants
to clear risk in a default scenario.”