The European Securities and Markets Authority has released the responses it has received to its first consultation paper on clearing obligation, specifically, the obligation to clear interest-rate swaps (IRS).
It posted this CP on July 11th, and allowed comments until August 18th.
I’ll just offer three quick points from the consultation paper as preface for the comments. ESMA classifies IRS’ thus: basis swaps; fixed-to-float swaps; forward rate agreements; overnight index swaps; options. It sees some difficulty in any effort to “establish a link between the activity of a fund and those described in the hedging definition, therefore [alternative investment funds] falling under the [non-financial counterparty] category should qualify their OTC trading as ‘non-hedging.’” Further, the CP includes a timetable for the mandate for central clearing, and offers Topic 4.1, an “analysis of the criteria relevant for the determination of the dates” as warrant for this table. The phase-in works on the basis of the different types of counterparties involved in a swap.
The Managed Funds Association, given its global nature, makes the point in its comment that many entities subject to the clearing obligation under development enter into contracts that are subject to analogous regulation in other jurisdictions, such as the U.S. and its CFTC. MFA expresses concern that cross-border derivatives contracts are going to be “subject to duplicative or conflicting clearing obligations.”
The International Swaps and Derivatives Association and FIA Europe sent a joint comment that says that they have “significant concerns” about the draft regulatory technical standards (RTS).
In general, ISDA/FIA Europe suggest that new and amended trades “that result from systemically risk reducing processes … and legacy trades which are amended in non-material ways or undergo a lifecycle event … should not be subject to the mandatory clearing obligation if the original trades were not subject to the clearing obligation.” Neither should derivatives entered into by structured finance SPVs.
More specifically, the trade groups propose that ESMA should require central clearing only in contexts where “at least two authorized or recognized CCPs clear a particular class of derivatives” in order to eliminated the risk of monopolies, bottlenecks, and related situations.
On the subject of hedging exposures: ISDA-FIA Europe contend that many funds, including real-estate and private equity funds, regularly enter into hedging transactions in just the same way that industrial corporations do. Thus, AIFs may legitimately be classified as non-financial counterparties themselves, a change that would delay some clearing obligations.
An Amiable Commenter
Other comments are quite amiable. BVI, the trade association for Germany’s fund industry, agrees with much of the consultation paper. For example, in setting out a timetable ESMA is committed to take into account the expected volume of various classes of OTC derivatives, whether one or more CCP already clears a particular class, the ability of the CCP to handle the expected volume, and so forth.
In connection with the volume expectations, the paper said that “the classes proposed … are already cleared in substantial volumes and, in some cases, already subject to the clearing obligation in other jurisdictions.” Also, ESMA believes that scalability of clearing operations has been validated by the re-authorization of CCPs under the European Market Infrastructure Regulation (EMIR).
To this, BVI replies, “We agree in general with the analyses. According to our observation, the client clearing offerings provided both on the level of the CCPs and of the clearing members are in principal sufficiently broad to support the introduction of the clearing obligation of the OTC interest rate classes as foreseen for regulated investment funds (UCITS/AIF) in the consultation paper.”
Revisiting a UCITS Issue
Where BVI does get its dander up it is over an issue that strictly wasn’t part of the CP to which it is responding at all. It digresses to discuss appoint from ESMA’s Guidelines on ETFs and other UCITS issues, a document issued in December 2012.
Paragraph of 42 in that document effectively bans the use of cash received in a repo transaction as collateral to the CCP. BVI objects that this hits UCITS especially hard, since UCITS are restricted in their use of leverage with reference to net asset value. BVI wants ESMA to amend those 2012 guidelines “in order to allow the German investment fund industry to continue to participate in the derivative markets by allowing sufficient cash from repo transaction to fulfill the collateral requirement under the EMIR regime.”