The Federal Act on Financial Market Infrastructures has introduced a new regulatory framework for over-the-counter (OTC) derivatives transactions. In line with recognised international standards (in particular, the European Market Infrastructure Regulation), the Federal Council and the Swiss Financial Market Supervisory Authority (FINMA) have recently published draft versions of their implementing rules (ie, the Financial Market Infrastructure Ordinance and the FINMA Financial Market Infrastructure Ordinance), which regulate the clearing obligation in more detail and define the criteria according to which derivatives are subject to a clearing obligation. The clearing obligation is expected to enter into force in 2016.
Like the European Market Infrastructure Regulation, the Federal Act on Financial Market Infrastructure identifies two categories of counterparty to which the clearing obligation applies:
- financial counterparties; and
- non-financial counterparties.
The following are considered to be financial counterparties:
- securities dealers;
- insurers and reinsurers;
- parent companies of a financial or insurance group or conglomerate;
- entities regulated pursuant the Federal Act on Collective Investment Schemes (including collective investment schemes); and
- pension funds and investment foundations.
Non-financial counterparties are all other legal entities that do not qualify as financial counterparties – such as industrial, commercial and service enterprises. Foreign corporations (including trusts or similar constructs) are covered insofar as they qualify as legal entities according the applicable law.
Financial counterparties with low derivatives positions and non-financial counterparties with low speculative (non-hedging) derivatives positions are exempt from the clearing obligation if certain clearing thresholds are not exceeded. In this case, they are considered to be small counterparties. Transactions that reduce risks directly relating to the commercial activity or treasury financing activity are considered to be hedging derivatives – for example, if they:
- cover the risks arising from the potential change in the value of assets and liabilities and the indirect impact on the value of assets, services or products resulting from fluctuations in interest rates, foreign exchange rates or credit rates; or
- qualify as a hedging contract pursuant to the International Financial Reporting Standards.
A financial counterparty is a small counterparty if all gross rolling average positions of its outstanding OTC derivatives are below the clearing threshold. A non-financial counterparty is a small counterparty if all of its gross rolling average positions are below the clearing thresholds in all relevant derivatives categories. A threshold is not deemed to be met if the relevant level has not been reached during a 30-day period, provided that the level has not been exceeded in the four preceding months. Exceeding the threshold triggers a clearing obligation for all derivative transactions (including hedging transactions) entered into by the relevant counterparty. The Federal Council has set the relevant thresholds in accordance with the thresholds that apply in the European Union, in particular for:
- financial counterparties at Sfr8 billion; and
- non-financial counterparties at Sfr1.1 billion for credit and equity derivatives, and Sfr3.3 billion for interest rate, foreign exchange and commodity derivatives.
Such positions are calculated as follows:
- They are based on actual currency rates;
- Derivatives positions that are cleared through a central counterparty on a voluntary basis must be included in the calculation;
- Positions of fully consolidated group entities must be aggregated;
- Changes in the nominal value during the term of the agreement are considered only if they are already agreed at the execution date;
- Subsequent transactions in the chain of hedging transactions are considered to be hedging transactions; and
- Opposite positions in derivatives which relate to the same underlying instruments and are denominated in the same currency and with the same maturity date must be offset.
Finally, counterparties of public institutions and central banks are exempt from the clearing obligation.
The clearing obligation applies to all financial counterparties and non-financial counterparties incorporated in Switzerland that enter into derivative agreements, as well as to all foreign branches of Swiss-based entities. Swiss branches of foreign entities are exempt if FINMA recognises the applicable foreign law as equivalent to the Swiss regulations. Further, the Federal Act on Financial Market Infrastructure will affect cross-border transactions. The clearing obligation applies in the event that the foreign counterparty to the derivative agreement is considered a counterparty if it was subject to the clearing obligation when incorporated in Switzerland, unless such a foreign counterparty is already subject to the clearing obligation under equivalent foreign regulations.
Generally, the clearing obligation applies to counterparties of all OTC derivatives agreements, irrespective of which documentation is used (eg, International Swaps and Derivatives Association (ISDA) master agreement or Swiss master agreement for OTC derivative instruments). Securities, structured products, repos, stock lending and certain agreements referencing commodities are not deemed derivatives. Further, derivatives in the form of transferable securities or book-entry securities and derivatives in the form of deposit transactions are outside the scope of the act. OTC currency swaps and foreign exchange forwards, when settled by means of a payment-versus-payment mechanism, are not subject to the clearing obligation. Ultimately, the determination of whether a derivative must be cleared through a central counterparty lies with FINMA – the decisive criterion is eligibility.
All eligible derivatives transactions entered into among financial counterparties and non-financial counterparties (except where a counterparty to a derivative is a small counterparty) are subject to the clearing obligation. Consequently, such transactions must be cleared through a central counterparty that is authorised or recognised by FINMA. Intragroup transactions are exempt from the clearing obligation if, among other things, both counterparties are subject to the same full consolidation and to appropriate centralised risk evaluation, measurement and control procedures.
FINMA has defined the eligibility criteria as follows:
- a high degree of legal standardisation (eg, using ISDA master agreements or Swiss master agreements for OTC derivative instruments);
- a high degree of operational standardisation;
- margins or financial requirements of the central counterparty which are proportionate to the risk that the clearing obligation intends to mitigate;
- stability of market size and depth in respect of the product over time;
- the likelihood that market dispersion will remain sufficient in the event of default of a clearing member;
- the number and value of the relevant derivatives transactions;
- evidence of availability to market participants of accepted pricing information; and
- increased systemic risk when counterparties cannot comply with their obligations.
To the extent that the clearing obligation applies, a central counterparty will step into the contractual relationship between the original parties to the transaction. FINMA will publish an up-to-date overview of all derivatives in a circular that will be subject to the clearing obligation. In addition, FINMA must determine each derivative category on the implementation timeline for the clearing obligation.
The clearing obligation is generally specified in the authorisation or recognition which FINMA grants to both Swiss and foreign central counterparties respectively. FINMA will determine which derivatives that are already cleared through the central counterparty will fall into a category of derivatives, that is subject to the clearing obligation according to the criteria.
The Federal Act on Financial Market Infrastructure will enter into force on January 1 2016. The act's implementing rules (the Financial Market Infrastructure Ordinance and the FINMA Financial Market Infrastructure Ordinance) were published in August 2015 and the public consultation on both ordinances ended on October 2 2015. The implementation timeline for the clearing obligation is linked to FINMA's obligation to define which derivatives not traded over a trading platform must be cleared via a central counterparty.
It is therefore expected that the clearing obligation will enter into force not earlier than:
- July 2016 for new transactions between participants of central counterparties;
- October 2016 for new transactions between participants of central counterparties and financial counterparties, or between financial counterparties among themselves; and
- January 2017 for all other new transactions.
For further information on this topic please contact Ansgar Schott or Martina Kessler at FRORIEP by telephone (+41 44 386 6000) or email (email@example.com or firstname.lastname@example.org). The FRORIEP website can be accessed at www.froriep.com.
This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.