EU Commission mandates OTC derivatives clearing
The European Commission has adopted new rules that make it mandatory for certain OTC interest rate derivative contracts to be cleared through central counterparties.
Mandatory central clearing is being introduced following commitments made by world leaders at the G-20 Pittsburgh Summit in 2009, to improve transparency and mitigate risks in the wake of the global financial crisis. The initial move covers interest rate swaps denominated in euro, pounds sterling, Japanese yen or US dollars that have specific features, including the index used as a reference for the derivative, its maturity, and the notional type (i.e. the nominal or face amount that is used to calculate payments made on the derivative).
The clearing obligations will enter into force subject to scrutiny by the European Parliament and Council of the EU and will be phased in over three years to allow additional time for smaller market participants to begin complying.
“Today we take a significant step to implement our G20 commitments, strengthen financial stability and boost market confidence,” said Jonathan Hill, EU Commissioner for Financial Stability, Financial Services and Capital Markets Union. “This is also part of our move towards markets that are fair, open and transparent.”
Part of the impetus for the European Commission’s first step is that interest rate derivatives constitute the largest segment of all OTC derivative products, making up around 80% of all global derivatives as of December 2014. The estimated daily turnover in the EU of OTC interest rate derivative contracts denominated in G4 currencies was over €1.5 trillion as of April 2013.
The central clearing obligation is taking effect as a delegated regulation under EMIR. This means that national regulators will have to transpose it into national law in each of the EU member states. This is the first clearing obligation that has been proposed by ESMA and it is expected that ESMA will propose obligations for other types of OTC derivative contracts in the near future.
The contracts affected are: fixed-to-float interest rate swaps, known as ‘plain vanilla’ interest rate derivatives; float-to-float swaps, known as ‘basis swaps’; forward rate agreements; and overnight index swaps.
While the European Commission stated that it believes mandatory clearance through CCPs brings many benefits, it also acknowledged one of the main criticisms of central clearing, that it increases the systemic importance of those CCPs within the financial system, and could therefore produce severe consequences if a CCP were to fail. The Commission said its 2015 Work Programme includes a commitment to legislate for a European framework for the recovery and resolution of CCPs.