General

European Market Infrastructure Regulation (EU) No. 648/2012 (EMIR) requires certain classes of OTC derivatives to be cleared through a central counterparty (a CCP). This is colloquially referred to as the “clearing obligation” or “mandatory clearing”.

All EU financial counterparties (FCs) and EU non-financial counterparties over the clearing threshold (as specified in Art. 11 of Regulation No. 149/2013) (NFC+s, and together with FCs, In-scope Counterparties) will be subject to the clearing obligation when they transact with (i) another FC or NFC+; or (ii) a non-EU entity which would be classified as an FC or an NFC+ if it was established in the EU.

OTC derivatives involving pension schemes, as well as intra-group OTC derivatives, are exempt from the clearing obligation (in the case of the former, currently until 16 August 2017) subject to certain conditions.

Latest developments

The clearing procedure started in Q1 2014 following the first authorisations of EU CCPs. Since then, the European Securities and Markets Authority (ESMA) has analysed interest rate, credit, equity and foreign-exchange OTC derivatives and proposed that interest rate and credit OTC derivatives become subject to central clearing by developing relevant regulatory technical standards.

Recapping the most recent developments:

  • On 21 December 2015, the regulatory technical standards (the G4 IRS RTS) on the clearing of certain interest rate OTC derivatives (each a G4 IRS Contract) settled in EUR, GBP, JPY or USD entered into force.
  • On 9 May 2016, the regulatory technical standards (the Index CDS RTS) on the clearing of certain credit OTC derivatives (index credit default swaps) (each an Index CDS Contract) entered into force.
  • On 10 June 2016, the final draft of the regulatory technical standards (the non-G4 IRS RTS) on the clearing of certain interest rate OTC derivatives (each a non-G4 IRS Contract and together with the G4 IRS Contracts and the Index CDS Contracts, the In-scope Contracts) settled in SEK, PLN or NOK were adopted by the European Commission (the EC). The final draft must now be accepted by the European Parliament and the Council and published in the Official Journal of the EU before it takes effect.
  • On 13 July 2016, ESMA published a consultation paper (the Consultation Paper) proposing to change the phase-in period for central clearing of OTC derivatives applicable to financial counterparties with a “limited volume of activity”(1) (please see section “Timeline for In-scope Contracts” below).
  • On 20 July 2016, the regulatory technical standards (the non-G4 IRS RTS) on the clearing of certain interest rate OTC derivatives (each a non-G4 IRS Contract and together with the G4 IRS Contracts and the Index CDS Contracts, the In-scope Contracts) settled in SEK, PLN or NOK were published in the Official Journal of the EU and are to take effect on 9 August 2016.

Timeline for In-scope Contracts

Following the effectiveness of the G4 IRS RTS, the Index CDS RTS and the non-G4 IRS RTS respectively, In-scope Counterparties must comply with:

  • the clearing obligation: this requires In-scope Contracts between In-scope Counterparties that are entered into on or after the effective date for the clearing obligation for those In-scope Counterparties to be cleared through a CCP (unless exempt); and
  • the frontloading obligation: this requires In-scope Contracts between In-scope Counterparties that are entered into (i) after the effective date for the frontloading obligation for those In-scope ounterparties but (ii) before the effective date for the clearing obligation for those In-scope Counterparties, to be cleared (by such effective date) through a CCP (unless exempt).

Both the clearing obligation and the frontloading obligation with respect to each category of the In-scope Contracts are to be “phased in" (2). The phase-in start dates are based on the categorisation of In-scope Counterparties:

  • Category 1 (Clearing Members): (i) clearing obligation – 21 June 2016 (G4 IRS Contracts) or 9 February 2017 (Index CDS Contracts) or 6 months after the entry into force of the non-G4 IRS RTS (non-G4 IRS Contracts); (ii) frontloading obligation – 21 February 2016 (G4 IRS Contracts) or 9 October 2016 (Index CDS Contracts) or 2 months after the entry into force of the non-G4 IRS RTS (non-G4 IRS Contracts) (in each case, to Category 1 clearing start date);
  • Category 2 (FCs and NFC+ alternative investment funds (AIFs) above the clearing threshold of EUR 8 billion): (i) clearing obligation – 21 December 2016 (G4 IRS Contracts) or 9 August 2017 (Index CDS Contracts) or 12 months after the entry into force of the non-G4 IRS RTS (non-G4 IRS Contracts); (ii) frontloading obligation – 21 May 2016 (G4 IRS Contracts) or 9 October 2016 (Index CDS Contracts) or 2 months after the entry into force of the non-G4 IRS RTS (non-G4 IRS Contracts) (in each case, to Category 2 clearing start date);
  • Category 3* (FCs and NFC+ AIFs below the clearing threshold of EUR 8 billion): (i) clearing obligation – 21 June 2017 (G4 IRS Contracts) or 9 February 2018 (Index CDS Contracts) or 18 months after the entry into force of the non-G4 IRS RTS (non-G4 IRS Contracts); (ii) frontloading obligation – does not apply; and
  • Category 4 (other NFC+s): (i) clearing obligation – 21 December 2018 (G4 IRS Contracts) or 9 May 2019 (Index CDS Contracts) or 3 years after the entry into force of the non-G4 IRS RTS (non-G4 IRS Contracts); (ii) frontloading obligation – does not apply.

Where an In-scope Contract is concluded between In-scope Counterparties included in different categories, the phase-in start date for that In-scope Contract will be the later date.

Getting ready

In-scope Counterparties to In-scope Contracts are advised to start seeking confirmations as to their counterparties’ categorisation for the purposes of the G4 IRS RTS, the Index CDS RTS and the non-G4 IRS RTS respectively, in order to undertake an assessment by when any In-scope Contract will need to be cleared and whether the frontloading obligation applies. Such confirmations can be done bilaterally (and a template ISDA EMIR Classification Letter can be used for these purposes) or using industry platforms (such as the ISDA Amend EMIR Clearing Classification Tool). When providing the requisite information, an In-scope Counterparty should carefully assess if this would constitute a formal representation under its trading documentation with other relevant counterparties the breach of which would result in a default under any such documentation. Since the clearing obligation is fast approaching, In-scope Counterparties should now also be taking steps to:

  • choose a Clearing Member through which they will access the CCP(s). The prevailing market practice is to appoint one primary Clearing Member and one ”back-up” Clearing Member. The reason for appointing the latter is to mitigate the risk of not being able to access the CCP if, for instance, the primary Clearing Member has defaulted;
  • consider which CCP(s) they want to access. Any CCP will need to be authorised or recognised in accordance with EMIR. Importantly, In-scope Counterparties should diligence the applicable rules of any considered CCP(s) to understand what protections are available to them as the client clearing offering will differ between CCPs; and
  • start negotiating the clearing documentation. If an In-scope Counterparty fails to have in place its client clearing arrangements with at least one Clearing Member by the time it needs to comply with the clearing obligation, it will be unable to access clearing. This may prevent it from entering into In-scope Contracts until it has negotiated, and entered into, its clearing documentation. Given the anticipated large number of In-scope Counterparties needing to finalise the client clearing arrangements, all relevant market players should ensure that sufficient time remains in order to do so.