Clearing access: Mind the gap!

In October 2012, The Trade reported that the European Parliament’s Economic and Monetary Affairs Committee (ECON) had rowed back from the European Commission’s proposal to open up access to trading and clearing infrastructure.

The MEPs’ final MiFID II text eliminated open access requirements for listed derivatives, restricting it to equities and bonds only. Exchanges argued at the time that if multiple CCPs cleared for the same derivatives market, fragmentation would increase and netting would suffer.

In mid-February, the Irish Presidency circulated a draft compromise text on clearing access.

The text noted that under EMIR direct interoperability for transferable securities and money market instruments can be rejected or restricted only to control any risks arising from that arrangement.

Direct interoperability for other instruments (including all derivatives) is not currently allowed. By September 2014, the European Securities and Markets Authority (ESMA) will submit a report to the Commission on the extension of the scope of interoperability arrangements to transactions in classes of financial instruments other than transferable securities and money market instruments.

If ESMA concludes that direct interoperability is safe and workable from a technical point of view, the Commission may introduce a proposal to extend direct interoperability to other financial instruments including derivatives.

EMIR’s scope with regard to clearing access provisions is limited to OTC derivatives. However, the explanatory note accompanying the Irish Presidency draft points out that the definition of OTC derivatives in EMIR is “a derivative contract the execution of which does not take place on a regulated market“.

Derivatives traded on MTFs and OTFs would be classified as OTC derivatives and would therefore be subject to the clearing access provisions of EMIR. Article 8(4) of EMIR also states that access of a CCP to a trading venue will be granted only where such access would not require direct interoperability.

Since EMIR Level 1 does not provide for direct interoperability for derivatives, EMIR technical standards have established alternative arrangements to accommodate non-discriminatory clearing access for OTC derivatives and to deal with liquidity fragmentation – ‘indirect interoperability’. These technical standards are, however, also limited to OTC derivatives.

As EMIR allows direct interoperability for transferable securities and money market instruments, it also implicitly provides for open access with regard to transferable securities and money market instruments. The draft notes, however, that, there is “a regulatory gap with regard to exchange traded derivatives.”

At the same time, the Commission’s proposal for MiFIR provided for open clearing access for all financial instruments, without prejudice to Articles 7 and 8 of EMIR. Access to a CCP or a trading venue could only be denied under well-defined circumstances.

In its explanatory note, the Irish Presidency observes that these provisions have been restricted in subsequent compromise texts. It also recognises that there have been proposals to limit the scope of articles 28 and 29 of MiFIR to transferrable securities and money market instruments, as has been done in the European Parliament text.  

“Scoping out exchange traded derivatives from the access provisions in MiFIR or completely restricting access for them would, however, leave us with the same regulatory gap as occurred with EMIR,” the note points out.

To close this regulatory gap, the Irish Presidency has proposed a ‘two-speed’ clearing access.

Exchange-traded derivatives would have non-discriminatory access both to a CCP and to a trading venue, if such access results in that venue having only one CCP clearing a specific set of derivative contracts. A CCP can clear the same set of derivative contracts for multiple trading venues, provided that in each case, it is the only CCP clearing this set of derivative contracts for each of the trading venues concerned.

Once a trading venue has a CCP clearing a specific set of derivative contracts, access to that venue of another CCP to clear the same set of derivative contracts is allowed only if the venue and all CCPs concerned agree. In that event, adequate and permissible operational mechanisms would have to be established between all CCPs clearing the same derivative contracts on the trading venue and these would be specified in ESMA technical standards and would need to approved by all competent authorities.

Further evolution can be expected.