All clear—clearing obligations after EMIR

What are the clearing obligations for trades of over-the-counter (OTC) derivatives? Lewis Lee, associate at Morrison & Foerster, looks at the latest developments from the European Securities and Markets Authority (ESMA) in relation to centrally clearing interest rate derivatives.

Original news

Four interest rate swap (IRS) classes will need to be centrally cleared under ESMA’s final draft regulatory technical standards (RTS). The RTS define the types of IRS contracts which will have to be centrally cleared, the types of counterparties covered by the obligation and the dates by which central clearing of IRS will become mandatory. ESMA has submitted its final draft IRS RTS to the European Commission, which now has up to three months to endorse the standards.

What is the background to the proposals?

The European Market Infrastructure Regulation (EMIR) places a number of obligations on counterparties to OTC derivative transactions. These include the central clearing of trades deemed to be subject to a ‘clearing obligation’. Although EMIR has been in force for over two years, the clearing requirement has taken time to implement and confirmation of its effective date for different asset classes and counterparties has remained dependent upon a number of factors—not least the requirement for ESMA to determine which classes of derivatives trades should, in accordance with the criteria required to be satisfied under EMIR, be mandatorily clearable. On 1 October 2014, ESMA published its final report covering draft technical standards on the clearing obligation in respect of interest rate OTC derivatives.

What are ESMA’s technical standards that are being proposed in this consultation?

Among other things, the report provides details of the classes of interest rate derivative products that shall be centrally clearable, being:

  • fixed-to-floating IRS
  • floating-to-floating IRS (known as basis swaps)
  • forward rate agreements, and
  • overnight index swaps

The report also sets out details of when the clearing obligation is likely to apply, which is itself determined by a categorisation of market participants. Broadly, counterparties are divided into four categories, dependent upon their classification under EMIR and whether or not they are a clearing member of a clearinghouse or are an alternative investment fund. Details are also provided in respect of frontloading.

What are the next steps?

The report is submitted to the European Commission. The Commission has three months within which to adopt the draft RTS included therein in the form of a Commission Regulation. Assuming the RTS are adopted by the end of the three-month period, this means that the first phase of category 1 clearing obligations (ie those that are applicable to clearing members of a recognised or authorised central counterparty) will come into effect in mid-2015.

How should lawyers and their clients prepare for the proposed changes?

European entities that trade OTC derivatives and non-EU established entities that trade OTC derivatives with EU counterparties, or with other non-EU counterparties where there is a significant connection to the EU, should be aware of their classification under EMIR and the extent to which they might be subject to mandatory central clearing of their derivatives transactions. To the extent that a particular counterparty will be affected, it should consider the nature of any interest rate derivatives it trades (and whether such trades are likely to be subject to a ‘clearing obligation’) and the relevant counterparty’s consequent categorisation as presented in the report.

Interviewed by Anne Bruce.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

First published on LexisPSL Banking & Finance. Click here for a free trial.

Relevant Articles
Area of Interest