ESMA proposes ‘no-deal Brexit’ rule change for novation of uncleared OTC derivatives

European regulator publishes report with technical standards with provisions for a no-deal Brexit.

The European Securities and Markets Authority (ESMA) has published a final report with draft regulatory technical standards (RTS) on the clearing obligation under the European Market Infrastructure Regulation (EMIR).

In the event of a no-deal Brexit, the report proposes a limited exemption in order to facilitate the novation of certain non-centrally cleared OTC derivative contracts to EU counterparties during a specific time-window.

Where a UK counterparty may no longer be able to provide certain services across the EU, counterparties in the EU may want to novate their non-centrally cleared OTC derivative contracts by replacing the UK counterparty with an EU counterparty. However, by doing this, they may trigger the clearing obligation for these contracts, thereby facing costs that were not accounted for when the contract was originally entered into. The draft RTS allow UK counterparties to be replaced with EU ones without triggering the clearing obligation.

This limited exemption would ensure a level playing field between EU counterparties and the preservation of the regulatory and economic conditions under which the contracts where originally entered into. The window for such novation would be open for twelve months following the withdrawal of the UK from the EU.

“ESMA and other EU authorities and institutions have been clear on the importance for market participants to be prepared for Brexit, including the possibility of a no-deal scenario,” says Steven Maijoor, chair, ESMA. “The proposed regulatory change supports counterparties’ Brexit preparations and maintains a level playing field between EU counterparties, while addressing potential risks to orderly markets and financial stability.”

The draft RTS have been submitted to the European Commission for endorsement and are subject to the scrutiny of the European Parliament and of the Council.