Views on improving the integrity of global capital markets
07 October 2015

European Market Infrastructure Regulation: Starting Point for OTC Derivatives Union?

We all know “EMIR” is synonymous with ruler, chief, or commander. But there’s a new meaning for the term that investment professionals should be aware of — an acronym short for European Market Infrastructure Regulation.

EMIR is one of the pieces in the European Union (EU) financial services legislation puzzle, among the first of many proposed by EU lawmakers after the 2008 financial crisis. The main aim of EMIR is to make the clearing and reporting of over-the-counter (OTC) derivatives mandatory. The EU-level legislation followed the G20 meeting in 2009 where world leaders pledged to improve the transparency, efficiency, risk management, and the integrity of the OTC derivatives markets.

To meet the G20 commitments, EMIR requires that information on all European derivative transactions be reported to trade repositories (TRs) and be accessible to supervisory authorities, including the European Securities and Markets Authority (ESMA — see my related blog post). The mandatory reporting requirement aims to give policymakers and supervisors a clear overview of what is going on in the OTC derivative markets. EMIR also requires standard derivative contracts to be cleared through central counterparties (CCPs), and establishes organisational, business conduct, and prudential requirements for the registered CCPs.

The Building of an OTC Derivatives Union

While the bulk of the EMIR legislation, the so-called Level I rules, has been in force since August 2012, work is still ongoing on the technical details. With the Level II technical standards still under development by the European Commission (EC) and ESMA, the EMIR rules will not be applicable in their entirety in the EU Member States until the Level II work has been concluded.

In his speech on 22 September, ESMA Chair Steven Maijoor noted that his focus will now be on the full, practical implementation of the EMIR rules. As part of the mission, ESMA will allocate more resources to ensuring supervisory convergence, and thus consistent implementation, in all EU Member States.

Maijoor even noted that the full implementation of EMIR clearing and reporting rules will lead to an ‘OTC Derivatives Union.’ As EMIR is a Regulation, as opposed to a Directive, the rules will be implemented in the Member States at the same time and with equally stringent requirements — there will be no room for divergent application across the EU. The consistent implementation of regulatory reforms in the EU also will form one of the cornerstones of the planned Capital Markets Union (CMU).

Work on Technical Standards in Progress

ESMA has already been working on several of the expected technical standards. In 2013, the EC adopted Level II rules on colleges of supervisors for central counterparties and rules specifying the fees to be charged to trade repositories by ESMA. EMIR reporting requirements have been in force since February 2014, and the Commission currently has authorised six TRs to operate within the EU.

The first European CCPs were authorised in 2014. The same year, the Commission also adopted four ‘equivalence’ decisions for the regulatory regimes for CCPs in Australia, Hong Kong, Japan, and Singapore. The CCPs in these third-country jurisdictions will be able to obtain recognition in the EU, and can therefore be used by market participants to clear standardised OTC derivatives as required by EU legislation, whilst remaining subject solely to the regulation and supervision of their home jurisdictions. CCPs registered in the US have not yet been declared as equivalent.

In August 2015, the Commission adopted Level II rules that make it mandatory for certain OTC interest-rate derivative contracts to be cleared through CCPs. The decision is the first to implement the clearing obligation under EMIR. The requirement covers interest-rate swaps denominated in euro, pounds sterling, Japanese yen, or US dollars that have specific features, such as the index used as a reference for the derivative and its maturity.

The clearing obligations will enter into force once scrutinised by the European Parliament and Council of the EU (i.e., EU Member State representatives), most likely in December 2015. The clearing obligations will be phased in over three years to allow additional time for smaller market participants to begin complying. While this is the first clearing obligation that has been proposed by ESMA, it likely will propose obligations for other types of OTC derivative contracts in the near future. For example, index credit default swaps were added to the clearing obligation on 2 October 2015.

European Commission Review Process

The Commission is currently assessing the effectiveness of the EMIR framework and ran a public consultation on the regime between May and August 2015. The Commission received 185 responses from both private entities and national public bodies.

Also ESMA provided its input to the Commission’s review, noting for example that it proposes a rethink of the entire third-country equivalence and recognition process to increase its efficiency and effectiveness. Many of the private entities also highlighted the need for a more predictable third-country regime.

In the review documents submitted, ESMA also proposes amending EMIR to streamline the process for determining clearing obligations and to introduce tools allowing the suspension of the clearing obligation when certain market conditions arise. The Commission will develop its review recommendations based on the comments received.

CCP Recovery and Resolution Legislative Framework

In addition to EMIR, the clearing landscape in Europe is likely to be further shaped by new, additional legislation. The Commission is expected to publish a legislative proposal for a European framework for the recovery and resolution of CCPs later in 2015, most likely on 24 November. The Commission is expected to assess the systemic importance of CCPs in the clearing cycle, and the potential consequences of a failing CCP.

The consistency of EMIR rules with other EU legislation will also be assessed in the recently launched public consultation that focuses on the cumulative impact of EU financial services legislation, including inconsistencies, overlaps, and gaps.

CFA Institute will continue to monitor developments on OTC derivatives. Enhanced clearing and settlement of derivatives contracts is an important leg in the stool that makes the European financial markets safe and beneficial for all the users of capital markets.

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About the Author(s)
Maiju Hamunen

Maiju Hamunen was an analyst for the Europe, Middle East, and Africa (EMEA) region in the Capital Markets Policy Group at CFA Institute. She was responsible for developing research projects, policy papers, articles, and regulatory consultations that advanced the policy positions of CFA Institute.

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