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Statistics published by the International Swaps and Derivatives Association (ISDA) and the Bank of International Settlements (BIS) show that central clearing has increased further, particularly for over-the-counter (OTC) interest rate derivatives.
Regulatory activity has been focused on:
ESMA has launched a new Q&A tool.
Initiatives by ISDA in H1 2017 have included:
The Futures Industry Association’s (FIA) initatives has focussed on the US regulatory framework and potential reforms to it.
PRIME Finance has added new members to its board and held its sixth AGM.
Dexia Crediop S.p.A. v Commune di Prato related to an argument that an Italian counterparty did not have capacity to enter into swaps and that in any case the ISDA master agreement should be governed by Italian laws.
Deutsche Bank v Comune di Savona also related to an argument that mandatory Italian laws should apply to an ISDA master agreement.
In Ventra Investments Ltd (in creditors voluntary liquidation) v Bank of Scotland plc, Ventra alleged that it was induced to enter into trades by fraudulent and negligent misrepresentations.
AMT Futures Ltd v Marzillier and others was another jurisdiction case, in which the English courts determined that they did not have jurisidiction pursuant to Article 5(3) of the Brussels I Regulation.
In Mohammad Zadeh Khorassani v Kathrin Pflanz, the advocate general of the Court of Justice of the EU considered whether brokering the conclusion of a portfolio management agreement amount to the provision of investment services under MiFID I.
Actions were brought against certain banks alleging that the normal course of pricing components for Euro interest rate derivatives had been distorted.
In Barnett Waddington Trustees (1980) v The Royal Bank of Scotland , there was a dispute about the entitlement of RBS to add the costs of unwinding an interest rate swap to the amounts required to redeem a loan early.
The ISDA SwapsInfo website publishes daily information and weekly analyses of interest rate derivatives and credit default swap (CDS) transactions disclosed under US regulatory guidelines.
The analysis for the week ending 23 June 2017 showed that, for 2017 year-to-date:
In May 2017 BIS published semiannual OTC derivatives statistics at end-December 2016. These show that:
In November 2016, the EMIR Review was published, pursuant to Article 85(1) of EMIR.
Various bodies have written to the European Commission this half year to request that it considers certain issues, in the context of the Commission’s ongoing EMIR Review, including:
In May, the Commission proposed a first set of amendments to EMIR. These amendments will introduce simpler and more proportionate rules on OTC derivatives that will reduce costs and burdens for market participants, without compromising financial stability.
In June, the Commission proposed a second set of amendments to EMIR to enhance the supervision of third country CCPs and make the supervision of EU CCPs more coherent.
In May, Commission Delegated Regulation (EU) 2017/751 was published. This amended the deadline for compliance with clearing obligations for certain counterparties within Category 3 to 21 June 2019, two years beyond the original date the obligation was to come into force.
ESMA has established various memoranda of understanding (MoU) under EMIR over the past six months. The MoUs establish co-operation arrangements, including the exchange of information, regarding CCPs established and authorised or recognised in the below countries. All of them have applied for EU recognition under EMIR.
Originally the variation margin (VM) requirements were due to come into force on 1 March 2017. This led to industry bodies such as ISDA requesting regulatory forebearance in relation to this date and for a transitional period during which market participants could continue to execute new derivative transactions while they completed the necessary steps towards regulatory compliance for the relevant transactions.
This led to the US Commodity Futures Trading Association (CFTC) issuing relief and delaying the deadline for compliance by swap dealers registered with the CFTC with its Dodd-Frank VM rules until 1 September 2017.
The European Supervisory Authorities (ESAs)—the European Banking Authority, European Insurance and Occupational Pensions Authority and the European Securities and Markets Authority (ESMA)—published a statement in response to industry requests relating to operational challenges in meeting the deadline of 1 March 2017 for exchanging VM, saying that neither they nor competent authorities possess any formal power to disapply directly applicable EU legal text, and there was not time to seek legislative change.
The Board of the International Organization of Securities Commissions (IOSCO) issued a statement expressing concern that firms will not be able to comply fully with the pending VM requirements. They stated that if this were the case, there may be a reduction in their ability to hedge positions and a potential impact on liquidity. Such a result would undermine the work of IOSCO and the Basel Committee on Banking Supervision in establishing the minimum standards for margin requirements for non-centrally cleared derivatives and IOSCO’s objective to cooperate in developing, implementing and promoting adherence to internationally recognised and consistent standards of regulation, oversight and enforcement in order to protect investors, maintain fair, efficient and transparent markets and seek to address systemic risks.
The Financial Conduct Authority (FCA), in response to the statements made by the ESAs and IOSCO stated that it would take a risk-based approach and use judgment in its supervision of firms' progress, taking into account the position of particular firms and the creditability of the plans they have made.
For more information on the margin requirements for uncleared derivatives, see Practice Note: Margin requirements for uncleared derivatives.
The European Securities and Markets Authority (ESMA) published a peer review analysis of how EU competent authorities ensure that CCPs comply with the margin and collateral requirements of EMIR. The review highlights some inconsistencies between supervisory approaches and makes some recommendations to promote convergence. The report also identifies areas for improvement regarding risk model valuation and ongoing supervisory reviews.
CCPs are an increasingly important part of the financial system. Particularly following post-crisis reforms to mandate central clearing of certain standardised OTC derivatives, it is vital that CCPs themselves do not become a source of ‘too big to fail’ risk.
ESMA has published its framework for its 2017 pan-EU stress test exercise on CCPs.
The Financial Stability Board (FSB) has published a consultation paper: Guidance on Central Counterparty Resolution and Resolution Planning, which sought comments on aspects of CCP resolution considered core to the design of effective resolution strategies. It also sets out draft guidance on resolution and resolution planning for CCPs.
The World Federation of Exchanges (WFE) fed back on the FSB paper in March, arguing that recovery must be given every opportunity to succeed before resolution proceedings are invoked. It also stated that it is important nonetheless to have clear resolution plans and expectations in the event that the recovery plan has been exhausted.
The International Regulatory Strategy Group (IRSG) published a paper on CCPs post-Brexit, which looks at the current regulatory and legal status of CCPs and the effects on UK CCPs and the markets generally, if there is no change after Brexit.
In March, Steven Maijoor, the chair of ESMA, delivered a statement to a hearing on CCP recovery organised by the European Parliament’s Economic and Monetary Affairs Committee. In that statement, he shared his views on the legislative draft—and also some considerations inspired by ESMA’s practical experiences in relation to CCPs’ resilience, particularly on the progress made in establishing a regulatory framework for this sector and CCP stress-testing.
In April, ESMA issued an opinion on the European Commission’s proposal for the EU regulation of CCP recovery and resolution. The proposal gives CCPs’ National Competent Authorities (NCAs) supervision and early intervention powers in relation to CCP recovery. For CCP resolution, the proposal asks Member States to designate National Resolution Authorities (NRAs) to develop CCP resolution plans. In both cases, ESMA will have a mediator role to ensure consistency.
In May, the Presidency of the EU issued a compromise text amending the proposed regulation on the recovery and resolution of CCPs published by the European Commission in November 2016. The Presidency’s amendments emphasise the importance of avoiding the use of public funds in the resolution and recovery of CCPs as far as possible.
In June, ESMA published a consultation on guidelines on CCPs' conflict of interest management. The purpose of these guidelines is to set out the criteria CCPs should apply to avoid or mitigate the risks of conflicts of interest and to ensure a consistent implementation across CCPs. The guidelines are intended to build on generic provisions in relation to the management by CCPs of conflicts of interest prescribed in EMIR. Responses to the consultation are sought by 24 August 2017. ESMA expects to publish a final report on these guidelines by the end of 2017.
In June, Commission Implementing Regulation (EU) 2017/954 OF 6 June 2017 on the extension of the transitional periods related to own funds requirements for exposures to CCPs was published. The 15 month periods referred to in Article 497(2) of the Capital Requirements Regulation (EU) No 575/2013 (CRR) and the second sub-paragraph of Article 89(5a) of EMIR, are extended by an additional six months until 15 December 2017.
In June, the European Commission announced proposals for more robust supervision of CCPs. The Commission says that CCPs from the EU are already well regulated and equipped to deal with financial distress but further reforms are required to ensure a more consistent and robust supervision of CCPs in EU and non-EU countries in respect of emerging challenges. The proposal introduces a more pan-European approach to the supervision of EU CCPs, to ensure further supervisory convergence and accelerate certain procedures. Closer cooperation between supervisory authorities and central banks responsible for EU currencies is a key aim. For non-EU CCPs, the proposal builds on the existing third country provisions in EMIR and will make the process to recognised and supervise third country CCPs more rigorous for those which are of key systemic importance for the EU. The aim is to address important challenges in derivatives clearing as its scale and importance grows and to take account of the role played by third-country CCPs in the clearing of financial instruments relevant to EU financial stability.
ESMA has updated its list of recognised CCPs based in third countries. The list concerns the recognition of seven new non-EU CCPs:
In the consultation, which was launched on 15 December 2016, ESMA set out several proposals to enhance the data made publicly available by TRs and to increase the transparency to the public in general, as well as allowing the publication of certain figures required by EU regulations such as MiFID II and the Benchmarks Regulation (EU) 2016/1011.
Certain pension scheme arrangements or entities benefit automatically from a temporary exemption from the obligation of counterparties to clear certain classes of OTC derivatives that reduce investment risks directly related to their solvency, whereas other pension scheme arrangements or entities need to obtain a prior authorisation before benefiting from the exemption (in accordance with Article 89(2) of EMIR).
Various pension schemes have applied for that exemption and ESMA have permitted the below exemptions and provided opinions setting out the reasons for granting the exemption:
The European Commission has also adopted a delegated regulation that will exempt central banks and public bodies managing public debt in Australia, Canada, Hong Kong, Mexico, Singapore and Switzerland from the clearing and reporting requirements of EMIR.
In January, ESMA issued two opinions (here and here) confirming that a Swedish pension scheme arragnement could benefit from an exemption from the clearing obligation under Article 89(2) of EMIR.
The European Banking Authority (EBA) and ESMA have called for clarification of the requirements for credit, market and counterparty credit risk in the Capital Requirements Regulation (EU) 575/2013 (CRR) with the related obligations under EMIR. The aim is to ensure that only risks not already covered by specific financial resources for activities unrelated to clearing are to be covered by CRR requirements. ESMA and the EBA said this exclusion should also be extended to activities covered by interoperability arrangements.
ESMA has issued a consultation paper on trading obligation for derivatives under the Markets in Financial Instruments Regulation (EU) 600/2014 (MiFIR) (ESMA70–156–71). The consultation paper presents ESMA’s approach for determining which derivatives should be subject to the trading obligation based on feedback received from stakeholders. ESMA will consider all comments received by 31 July 2017.
On 22 February 2017 the FIA, the Global Financial Markets Association (GFMA), ISDA and the European Federation of Energy Traders (EFET) jointly submitted two comment letters to ESMA on the position limits regime to be introduced under MiFID II.
The first letter relates to the application of position limits to products listed in Annex I, section C.10 of MiFID II. FIA, GFMA, EFET and ISDA argue that position limits should only apply to those products with a link to commodities, ie not inflation swaps.
The second letter requests a clarification from ESMA that contracts traded on a third-country (ie non-EU) venue should not be considered OTC for the purposes of the position limits regime.
The FIA has responded to the latest proposal by the CFTC on position limits for derivatives. In a letter dated 28 February 2017, the FIA urges the CFTC to assess whether position limits are needed and to expand exemptions for hedging activities before setting any new federal position limits.
The FIA, the Global Financial Markets Association (GFMA), ISDA and the European Federation of Energy Traders (EFET) submitted draft Q&As on position reporting under Article 58 of MiFID II. This follows a joint letter these bodies submitted to ESMA in December 2016, setting out their views on position reporting. The draft Q&As reflect this position and propose a definition of end-client, clarify how positions of clients—and clients of those clients—should be repoted, and make suggestions on how duplicative reporting could be avoided.
The European Commission published a report on exemptions for third-country central banks and other entities under MiFIR. The study analyses the pre and post-trade transparency rules that apply when third countries’ central banks trade in securities, as well as to the extent these central banks trade in securities within the EU.
Following the report, the Commission has adopted a Delegated Regulation extending these exemptions granted by Articles 1(6) and 1(7) of MiFIR. These exemptions will now apply to transactions entered into by the Bank for International Settlements (BIS) and certain third country central banks.
ESMA launched a new Q&A tool, designed to provide easy access to stakeholders to consult existing Q&As and submit new questions. The tool is available on the new ‘questions and answers’ page, which contains an overview of all Q&As developed by ESMA per legislative act and instructions on submitting new questions to ESMA.
In January 2017, ISDA launched its Japanese jurisdictional module for the ISDA Resolution Stay Jurisdictional Modular Protocol, which is available on the ISDA website. It was effective from 1 April 2017.
The ISDA Resolution Stay Jurisdiction Modular Protocol (JMP) is an industry tool developed by ISDA for market participants to use when updating their documentation in response to the margin regulations for uncleared derivatives. It enables market participants to comply with these regulations aimed at ensuring the cross-border enforceability of stays on contractual termination rights and although it follows the launch of the ISDA 2015 Universal Resolution Stay Protocol, it is standalone. Each module contains the operative provisions necessary for adhering parties to comply with applicable requirements and has two main sections:
The ISDA SIMM (standing for ‘Standard Initial Margin Model’) is a methodology which firms can use to calculate initial margin. By using a standardised methodology, the risk of dispute between entities is reduced.
In March, ISDA published an additional document relating to the ISDA SIMM. The documents that have now been published are:
Article 55 of the BRRD requires in-scope entities to include a contractual term in agreements creating any relevant liability governed by the law of a third country to ensure their creditors recognise that the liability may be subject to bail-in under the BRRD, and agree to be bound by it. The Protocol provides an efficient means for markets participants to amend the terms of certain ISDA Master Agreements and other documentation to reflect those requirements.
ISDA announced the launch of its second bail-in Article 55 BRRD Protocol, which is designed to allow Austrian, Belgian, Danish and Swedish in-scope entities to meet the requirements of Article 55 of the Bank Recovery and Resolution Directive 2014/59/EU (BRRD).
The first protocol was launched in July 2016 for Dutch, French, German, Irish, Italian, Luxembourg, Spanish and UK entities. This latest launch extends coverage to 12 countries in total.
The German Institution of Arbitration (DIS) has adopted a model arbitration clause to be used with the ISDA 2002 ISDA Master Agremeent (and 1992 ISDA Master Agreement, with suggested amendments).
The availability of the DIS model clause follows the publication of ISDA’s 2013 Arbitration Guide which includes 11 model arbitration clauses and the Stockholm Chamber of Commerce (SCC) adopting an SCC-ISDA arbitration clause in 2015. That clause is available in Practice Note: SCC–ISDA model clause (Stockholm seat).
In the first half of 2017, ISDA has:
These appointments follow the appointment of a representative of a supranational and a central counterparty in September 2016, thereby diversifying the board and emphasising the importance of clearing in the OTC derivatives market.
The FIA published a policy white paper which contained recommendations for improving the US regulatory framework while enhancing the safety and stability of cleared derivatives market.
The recommendations fall into seven categories:
The FIA president and CEO, Walt Lukkan wrote an open letter to President Trump and key congressional and regulatory leaders requesting that a comprehensive review of all US Financial reform regulation should be undertaken.
PRIME Finance is a Hague-based panel of recognised market experts in finance. Its Panel is currently comprised of over 130 experts in total, with more than 4,000 years of collective relevant market and legal experience.
In January, 25 new members were added to its panel of experts, including Luc Frieden (former Luxembourgian Minister of Treasury and Finance, Minister for Defence and Minister of Justice), Professor Dr Carl Baudenbacher (President of the EFTA Court) and Professor Sir Bernard Rix (retired Lord Justice of Appeal, England and Wales).
PRIME also held it sixth annual conference in the Hague, Netherlands in January, at which Steven Maijoor, the chair of ESMA, spoke about the reforms of the OTC derivatives markets and benchmarks as well as the system of third country equivalence and ESMA’s role as mediator between national regulators.
There have been a number of derivatives cases in H1 2017. They have included:
The Court of Appeal overturned the first instance ruling of Dexia Crediop S.p.A. v Commune di Prato, dismissing an Italian counterparty’s attempt to avoid liability under an English law governed ISDA master agreement based on the continued applicability of mandatory Italian laws affecting capacity and the enforceability of financial agreements. It was held that the defendant had had capacity to enter into the swaps, its financial defences failed, as the mandatory rules of Italian law had no application to the swaps, and it had not been entitled to counterclaim for damages based on a statutory tort arising from the claimant’s alleged breaches of its obligations.
The Commercial Court ruled on an application by the defendant Italian local authority (Savona) against the claimant bank (Deutsche Bank), for a strike out and a stay of proceedings. The dispute arose after Savona had entered into two interest rate swaps with Deutsche Bank pursuant to an ISDA master agreement, which was governed by English law. The parties had also entered into another agreement that was governed by Italian law. Deutsche Bank brought a claim in England for certain negative declarations. Savona brought a claim in the Italian court.
The Commercial Court held that Savona's challenge to the English court's jurisdiction, in respect of some of the declarations claimed by Deutsche Bank, succeeded because the dispute, to which the relevant declarations related, for the purpose of Article 25 of the European Parliament and Council Regulation (EU) 12215/2012 (Recast), had to be regarded as the underlying Italian claim, and Deutsche Bank could not show a good arguable case that the Italian claim fell within the English clause. The application for a stay in respect of the remaining declarations was dismissed.
This case dealt with a situation where Ventra purchased four replacement interest rate swaps from The Bank of Scotland plc (BOS). Ventra alleged that it was induced to enter into these trades by negligent and fraudulent misrepresentations or negligent misstatements and negligent failure to provide an adequate explanation of the nature and effect of the swaps. BOS sought to have parts of Ventra's particulars of claim struck out and the Commercial Court allowed the application in respect of a number of paragraphs. The paragraphs in issue did not have sufficient relevance to the allegations of negligent misstatement made in the claim.
For more information, see news analysis: Striking out parts of a swaps claim (Ventra Investments v Bank of Scotland).
The Supreme Court dismissed the appellant company's appeal against a decision that the English courts did not have jurisdiction to hear its claim against the respondent company for damages and injunctive relief for the tort of inducing breach of contract in relation to certain derivative brokerage contracts. The contracts under which the breach was alleged to have occurred were governed by English law and provided that the English courts would have jurisdiction in legal proceedings relating to the contract. The court considered Article 5(3) of Regulation (EC) 44/2001 (Brussels I), which gives jurisdiction in tort claims to 'the courts for the place where the harmful event occurred or may occur' and determined that the English courts did not have jurisdiction as the relevant harm had occurred in Germany.
In this opinion, the advocate general of the Court of Justice of the EU considered whether brokering the conclusion of a portfolio management agreement amounted to the provision of investment services under the Markets in Financial Instruments Directive 2004/39/EC (MiFID I). Under Annex I, section A, paragraph 1 of MiFID I, investment services include 'reception and transmission of orders in relation to one or more financial instruments'. In the advocate general's view, 'orders' for this purpose are orders for specific financial instruments, cannot be likened to generic orders and cannot include activities aimed at the conclusion of a portfolio management agreement which does not entail an executable order in relation to a specific financial instrument.
On 10 April 2017, applications for actions brought on 17 February 2017 by HSBC Holdings plc and others and by JPMorgan Chase Co and others, against European Commission decision C(2016) 8530 were published in the Official Journal.
The case was in relation to traders of seven banks, who were in regular contact with each other through corporate chat-rooms or instant messaging services. The aim of the traders was to distort the normal course of pricing components for Euro interest rate derivatives; this was achieved through telling each other their desired or intended EURIBOR submissions and by exchanging sensitive information on their trading positions or on their trading or pricing strategies. The result of this collusion was that the banks did not compete with each other on the market for Euro interest rate derivatives.
These proceedings are the second set of proceedings about a secured loan given to the claimants by the defendant bank (RBS). The disputes were and are about the entitlement of RBS to add the costs of unwinding an interest rate swap to the amounts required to redeem the loan early. In the first set of proceedings ( EWHC 2435 (Ch)) Warren J held that the unwinding costs of the swap transaction then before him (which was an internal bank swap) could not be added to the redemption cost. For more information on the first set of proceedings, see News Analysis: Bank lenders and internal swaps.
The second set of proceedings ( EWHC 834 (Ch)) concerns a procedural issue—RBS, having discovered what it says is an external back-to-back swap (ie with an external counterparty), asserted that it would be entitled to add the costs of unwinding that swap to the redemption charges. In these proceedings, the claimants argued that the bank could no longer make that claim because it is res judicata (as they describe the point) in the sense that it ought to have been raised and dealt with in the first proceedings but was not.
The court held that the claimants were entitled to resist a claim that the bank is entitled to add the break costs from the produced external swap to the redemption charges were they to redeem the loan, because to advance such a claim would be an abuse of process. Summary judgment was given on the point.
This half year, we have published a number of new practice notes and checklists on derivatives. To view these documents, subscription to LexisPSL Banking & Finance is required. Want to have a free trial? Click here.
New Practice Notes:
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