The Dodd-Frank Wall Street Reform and Consumer Protection Act’s mandatory clearing requirement for interest rate swaps and certain credit default swaps has been in place for quite some time. However, the clearing requirement for these and other types of swap transactions under the European Market Infrastructure Regulation (EMIR) remains to be implemented. Recent developments suggest that, for most end-users, European clearing may still be some distance away.
Under EMIR, mandatory clearing is to be implemented as follows: the European Securities and Markets Authority (ESMA) is charged with developing regulatory technical standards (RTS) which, in turn, are subject to review by the European Commission (Commission). Following the endorsement of the RTS by the Commission, the RTS is subject to review by the European Parliament and the Council of the European Union. Barring an objection from the European Parliament or the Council of the European Union, the RTS is published in the Official Journal of the European Union (Official Journal) and is entered into force 20 days after publication.
At this time, the following actions have taken place with respect to implementing the mandatory clearing of interest rate swaps in Europe:
- ESMA submitted its final RTS to the Commission on October 1, 2014, following a notice and public comment period.
- The Commission responded with proposed amendments to the RTS on December 18, 2014, as discussed further below.
- In response to the Commission’s proposed amendments, ESMA issued a formal opinion and a revised RTS on January 29, 2015, as discussed further below.
If the Commission does not make any further changes to the revised RTS, the European Parliament and the Council of the European Union must decide by March 1, 2015, whether or not to approve the RTS; if changes are made by the Commission, the European Parliament and the Council of the European Union would have until July 1, 2015, to approve the RTS.
Once in effect, the mandatory clearing compliance dates are phased-in depending on an entity’s categorization under the RTS, as discussed further below. The proposed compliance dates range from six months to three years. As a result, some market participants may not be subject to clearing under EMIR until the second half of 2018.1
1. ESMA Responds to the Commission’s Amendments to the RTS on Interest Rate Swaps Clearing
Following ESMA’s publication of the RTS on October 1, 2014, the Commission sent a letter to ESMA, dated December 18, 2014, recommending certain changes to the RTS on interest rate swaps. Specifically, the Commission suggested:
- Postponing the requirement to “frontload” transactions. The “frontloading” requirement refers to the obligation to clear certain contracts entered into after a central counterparty (CCP) has been authorized under EMIR but before the date of application of the clearing obligation. Financial counterparties in Category 1 will be given two months after the date of entry into force of the clearing obligation to determine whether they are subject to the frontloading obligation. Financial counterparties in Category 2 are given five months.
- Providing clarity to investment funds with respect to the calculation of a threshold that distinguishes between classes of persons for purposes of when compliance with the clearing obligation will be required.
- Temporarily excluding transactions, between persons subject to EMIR and their affiliates who are not subject to EMIR, from the clearing obligation. (Such trades are referred to as “intragroup” transactions.”) The Commission’s proposal would, for a period of three years, permit financial counterparties to apply for an exemption with respect to their transactions with any third-country affiliates in the absence of equivalence decisions by ESMA.2
On January 29, 2015, ESMA responded to the Commission’s proposed amendments by issuing a formal opinion and revised set of RTS to implement the clearing requirement for interest rate swaps. In the formal opinion, ESMA provided the following comments, some of which are reflected in the revised RTS:
- ESMA supports the Commission’s suggestion to postpone the start date of the frontloading obligation to provide counterparties with sufficient time to determine whether their contracts are subject to the frontloading obligation.
- ESMA incorporated the Commission’s suggestion that the EUR 8 billion threshold for Category 2 entities applies at the fund rather than the group level when the counterparties are (1) undertakings for the Collective Investment in Transferable Securities (UCITS), or (2) AIFs. ESMA added a provision in Article 2 of its revised RTS to indicate that the EUR 8 billion threshold applies at the fund level when the counterparties are UCITS or AIFs.
- ESMA does not support the proposed exemption from the clearing obligation for non-EU intragroup transactions. ESMA questioned whether there was a legal basis for ESMA to grant such exemptions in any case.3 ESMA also expressed concern that the exemption could result in evasion of the clearing requirement under EMIR, in the event that an EU counterparty enters into an intragroup transaction with a non-EU counterparty established in a country where the Commission does not intend to make an equivalence decision. This would allow the EU counterparty, otherwise subject to EMIR’s clearing obligation, to avoid the clearing obligation for the stated period of time.
As noted above, the RTS will be subject to final approval by the Commission, followed by the European Parliament and the Council of the European Union, prior to publication in the Official Journal. The mandatory clearing obligation will then be subject to a phased-in compliance schedule. ESMA has indicated that it is planning to work with the Commission to adopt an alternative approach to the intragroup exemption.
2. ESMA Exempts FX NDFs from the Clearing Obligation, for Now
On February 4, 2015, ESMA released a feedback statement indicating that it is not planning to finalize RTS to impose a clearing obligation with respect to non-deliverable foreign-exchange forwards (FX NDFs).
In October 2014, ESMA published a consultation paper proposing RTS that would subject certain FX NDFs to clearing. The paper sought feedback from the public. Based on the feedback received, for the time being, ESMA has decided against subjecting FX NDFs to clearing. ESMA may determine to impose a clearing obligation with respect to FX NDFs at a later point in time.
ESMA’s decision to hold off on finalizing RTS to subject FX NDFs to clearing was based on concerns related to (1) the timing for the entry into force of a potential clearing obligation on FX NDF classes and its link with the clearinghouses available to clear FX NDFs; (2) market participants’ experience with FX NDF clearing; and (3) the importance of international consistency in the implementation schedule of the clearing obligation.
In contrast to ESMA’s treatment of FX NDFs, ESMA has delayed, until the Commission has concluded its review of the final RTS on interest rate swaps, publication of the final RTS that would impose the clearing obligation on certain credit default swaps (CDS). ESMA published draft RTS on CDS clearing for public comment on July 11, 2014, and was due to release final RTS last November. The purpose of ESMA’s delay is to ensure that it can incorporate certain items that overlap with the interest rate swaps clearing RTS into the CDS clearing RTS.