A three-month extension may not provide enough time to complete new rules for trading and clearing OTC derivatives unless regulators draw substantially on industry experience, market participants warn.
Earlier this week, sources close to the matter confirmed the European Securities and Markets Authority (ESMA), the region’s securities watchdog, would now have until 30 September to complete the technical standards for the European market infrastructure regulation (EMIR).
But many consider the scale of the task facing ESMA could be insurmountable in the eight months it has, unless there is strong involvement from the industry.
EMIR will require OTC derivatives to be standardised so that they can be centrally cleared, traded on exchange-like trading platforms and reported to newly-created data repositories, in line with Group of 20 (G20) commitments agreed in 2009.
The technical standards, which are known as level two rules, will decide which derivatives can be standardised – a decision ESMA will take in conjunction with central counterparties (CCPs). Level two rules must also ensure the regulation is consistent with other international reforms and determine the types of assets eligible for initial and variation margin. ESMA will create the laws using implementing acts, which will impose uniform legislation across the continent, and delegated acts, which will allow member states some room for discretion.
By the end of the month, ESMA is expected to launch a consultation period on the best way to tackle these issues. It is currently unclear how long the consultation will run for.
A question of timing
Central counterparties say issues relating to acceptable collateral and standardisation of instruments demand industry collaboration. Many CCPs have already pre-empted EMIR by expanding both the scope of products they clear and assets they accept as collateral. For instance, Eurex, the derivatives market owned by Deutsche Börse, began clearing interest rate and equity derivatives from March 2011, while in October 2011 Anglo-French clearing house LCH.Clearnet started accepting gold bullion as a means of covering margin liability.
“The forthcoming consultation will provide many of the principles that will govern issues including eligibility of derivatives for clearing and CCP treatment of collateral,” said Diana Chan, CEO of EuroCCP, the European cash equity clearer owned by US post-trade facility DTCC. “But the September deadline leaves very little time to get the rules associated with the legislation finalised. Ideally, the industry would need to be given more time to comply than the end of this year.”
After ESMA completes its work, the European Commission will then have until the end of December to approve the rules for use from the start of 2013, as per guidelines by the G20.
ESMA itself is already anxious at the task that lies ahead.
“The deadlines on EMIR are – to say the least – challenging, considering that we need to meet the G20 deadlines,” said Steven Maijoor, ESMA chair, at a conference held by sell-side trade body the Association for Financial Markets in Europe at the start of February. “However, I hope and expect that for the technical standards regarding EMIR, we will receive the time needed.”
Phased approach wanted
For market participants, most expect EMIR to be enforced on a step-by-step basis, initially targeting those instruments that are easiest to standardise.
“ESMA will likely design the rules so that they can be implemented on a phased basis,” said Alex McDonald, CEO of inter-dealer broker trade body the Wholesale Markets Brokers’ Association. “Those areas that are already widely cleared, i.e. interest rate swaps and credit default swap indices, are likely to be targeted first. However, ESMA needs to find a way to strike a balance between the practicability of clearing certain instruments and the capacity of clearing houses to do so.”
McDonald said such a balance would continually shift as the industry became more familiar with the new environment and as technology for pricing and valuations of exposures improved, making it easier for buy-side firms to self-clear more instruments. Most buy-side firms are expected to use an intermediary to manage their clearing obligations, but larger asset managers may prefer direct connectivity to CCPs because of the increased control and greater capital efficiencies they may achieve.
The European Parliament and Council of the European Union reached an agreement on EMIR on 9 February. The legislation would have been agreed sooner had it not been for disagreement over the role of the ESMA in resolving disputes between national securities regulators on the authorisation of central counterparties used to clear standardised OTC derivatives.