Dec 22, 2014

Almost three months after ESMA published the final draft RTS on Clearing Interest Rate Swaps (IRS) under EMIR, the clearing landscape starts getting clearer.  Clearing could be the most complex regulatory obligation under EMIR so far. When combined with the lack of guidance from the regulators, it seems to have raised more questions than answers.  In our previous article we highlighted some of the major issues and uncertainties faced by the financial industry. It is probably worth reiterating these in order to give some context around the latest developments and their impact. These can be summarised as follows:

  • Calculation of the frontloading threshold – lack of guidance on this has led many to question its usefulness and ability of counterparties to calculate it in accordance with the proposed timelines
  • Counterparty representation – with the industry tool – ISDA Amend only expected to be ready in Q2 2015 and the bilateral version of it still not finalised either, there is currently no means by which counterparties can do their representations.
  • Pricing- frontloading creates uncertainty about how bilateral OTC trades should be priced.
  • Timing – lack of clarity on the calculation of the frontloading threshold to determine the scope of the requirement and lack of means by which counterparties could do their representation, the major concern in the industry has been whether current timelines would hold or be pushed back.

These issues have been a major source of concern in the industry and many had turned their sights to ESMA and the European Commission (EC) for further guidance. The long awaited moment came on 18 December when the Commission sent a letter back to ESMA endorsing an amended RTS on IRS clearing. Below are outlined the major amendments proposed in the letter:

  • The frontloading requirement for Category 1 should be postponed by two months after the entry into force of the RTS. This is largely attributable to the fact that entities will have to calculate the price of frontloading, reflect this in their contracts and communicate to their counterparties whether they would be subject to the frontloading requirement.
  • The Commission also announced that the calculation of the frontloading threshold will take place over the period of three months after the entry into force of the RTS, as opposed to three months prior to its entry as originally suggested by ESMA. Therefore, the frontloading requirement for Category 2 is expected to start five months after the entry into force of the RTS, which will give counterparties enough time to assess their eligibility for the frontloading requirement and make their representations.
  • The Commission deemed it necessary to provide clarification on the calculation of the frontloading threshold for investments funds, which is to be done on an entity level (i.e. per single fund) as opposed to group level reflecting their distinct legal nature.
  • Finally, it was communicated that non- EU intragroup transactions (i.e. transactions entered into between EU and non-EU entities part of the same group) would be exempt from clearing for a period of three years until the Commission adopts equivalence decisions pursuant to Article 13 of Regulation (EU) 648/2012 for their permanent exemption.

The publication of this letter was welcomed by both ESMA and the entire industry, which will now have more time to prepare operationally for the clearing requirement. Based on the proposed amendments, the RTS is currently expected to come into force in April 2015, with frontloading for Category 1 expected to start two months later in June 2015, followed by frontloading for Category 2, three months after that in September 2015. This will give more time for counterparties to familiarise themselves with the requirements and prepare operationally. It will also give ISDA more time to finalise and implement the means by which counterparty representation is to be made in line with the new deadlines.

Following over two months of tension in the industry since ESMA submitted its final draft RTS on IRS clearing, the Commission’s letter to ESMA has come as a relief to many, showing the authorities’ receptiveness to the industry-wide concerns. We have now embarked on arguably the most challenging and complex journey for EMIR, but this letter has marked an important milestone in line with ESMA’s overarching objective of reducing systemic risk and making financial markets more resilient to future storms, despite the long road ahead of us.