The swaps market received an early Christmas present this week as the European Commission lightened the burden for loading existing derivatives trades into central clearing by postponing the start-date for the controversial frontloading requirement.
Under new proposals, counterparties will not be required to shift outstanding uncleared swaps into clearing houses until months after the final list of instruments for mandatory clearing is confirmed through the publication of Regulatory technical standards in the Official Journal.
In a letter to the European Securities and Markets Authority, the Commission proposed that the start date for frontloading should be postponed until two months after publication of the RTS for Category 1 clients and five months after publication for Category 2 clients. That effectively moves frontloading to April 2015 for clearing members, and July for other financial counterparties with more than €8bn gross notional of outstanding swaps.
The change aims to bring greater clarity over whether contracts are subject to the clearing obligation before they are entered into – something that was proving a headache when it came to pricing uncleared trades that may or may not be subject to the clearing mandate.
”Frontloading should not start for counterparties in Category 1 until they can know whether they benefit from the exemption from clearing,” notes Jonathan Faull, director general for Internal Market and Services at the EC in his letter to ESMA chairman Steven Maijoor.
The Commission also highlighted the importance of certainty around client categorisation – something that the original timetable failed to take into account.
”Financial counterparties other than Category 1 should not be subject to frontloading before they can know whether they reach the threshold to fall under Category 2 and before they have sufficient time to make the necessary arrangements for frontloading to take place.”
As part of the new proposal, ESMA suggested that the period for calculation of the threshold should be three months following the publication of the RTS.
Initial proposals required swaps counterparties to move trades into central clearing if they were entered into after CCPs became authorised under the European Markets Infrastructure Regulation. The first such authorisation was granted by ESMA in March of this year, yet the first wave of the clearing obligation is unlikely to take hold until mid-2015 with full compliance at least two years later.
However, in its final draft RTS, ESMA reduced that burden to apply to swaps that were transacted only from the point of publication of the final RTS in the official journal.
The additional time will prove a lifeline to mid-tier financial counterparties that call into the Category 2 segment as they now have until July before their swaps become subject to the clearing obligation.
“In an ideal world, frontloading wouldn’t apply, but the Commission has bought many entities in Category 2 an additional five months and 21 days. That’s definitely a good thing considering the time it takes to establish clearing arrangements,” said Deepak Sitlani, derivatives partner at Linklaters.
He noted that while counterparties subject to the first wave of clearing are already up and running given that they are classified as being clearing members, many category two participants are yet to get clearing agreements in place.
It is proving a time-consuming process with many documents running at over 100 pages in length, creating concerns of a bottleneck after the expected RTS publication date of late January 2015.
“It would have been quite a rush to have documents agreed for February. For those Category 2 entities that still have to establish their clearing arrangements, it has given them breathing space to carry on with negotiations, particularly given the natural capacity constraints of a limited number of clearing members,” said Sitlani.