Derivatives clearing, exchange-trading and collateral in United Kingdom

Types of transaction

What categories of equity derivatives transactions must be centrally cleared and what rules govern clearing?

EMIR will require most OTC derivatives transactions to be cleared, though the applicability of this obligation is subject to certain thresholds depending on the nature and size of a counterparty and its derivatives trading. This clearing obligation is coming into force in phases and currently does not apply to OTC equity derivatives, but it is expected to in future (though this is not imminent and there is no timeframe for this). The rules relating to clearing are set out in EMIR (which acts as a framework regulation) as well as subsequent technical standards, which set out further details and requirements related to the clearing obligation. Whenever a new class of OTC derivative is approved for clearing, a new set of technical standards will be published, and these will provide detailed requirements in relation to the clearing of that particular class of OTC derivative. EMIR is being amended this year by the EMIR Refit that, among other changes, will make it less likely that small financial counterparties will be required to clear derivatives. These amendments do not particularly impact equity derivatives.

What categories of equity derivatives must be exchange-traded and what rules govern trading?

The types of equity derivative that are exchange-traded are typically futures and exchange-traded options. MiFID II/MiFIR introduced a mandatory trading obligation for certain derivative transactions that require such transactions to be executed on exchange or on other specified types of trading venue (see question 3). Broadly, the trading obligation only applies to a class of derivatives that is admitted to trading or traded on at least one admissible venue (the venue test) and the derivatives are determined to be sufficiently liquid (the liquidity test). The trading obligation in respect of derivatives currently applies only to certain interest rate swaps and index CDS and does not currently apply to equity derivatives.

Describe common collateral arrangements for listed, cleared and uncleared equity derivatives transactions.

For cleared OTC equity derivatives transactions, the parties will usually be required to post both initial margin and variation margin.

For uncleared OTC derivative transactions, the most common forms of collateral arrangement are title transfer or security interest. Title transfer is far more common. If the equity derivative is documented using an ISDA Master Agreement then this type of arrangement is commonly documented using a credit support annex, which will set out, among other things, the types of collateral that may be transferred, how the amount of collateral to be transferred will be calculated, the frequency of such transfers and operational details surrounding the transfer.

For listed exchange-traded equity derivatives, the rules as to collateral will be determined by the relevant clearing house. However, both initial margin and variation margin are likely to be required.

Must counterparties exchange collateral for some categories of equity derivatives transactions?

Yes. EMIR requires the exchange of variation margin between financial counterparties (broadly, banks, funds and certain other types of non-bank financial institutions) for derivatives transactions entered into from 1 March 2017. (EMIR also imposes an obligation on financial counterparties to exchange initial margin, but this obligation is coming into force on a rolling basis. It currently applies to derivatives between financial counterparties that each have outstanding derivatives books of over €1.5 trillion and will apply to such parties that each have outstanding derivatives books of over €750 billion from 1 September 2019. This threshold is currently expected to be reduced to €8 billion from 1 September 2020.) Most derivatives transactions are in scope for these margining obligations, although single stock equity options and index option transactions will be outside scope for a transitional period.

There is currently no clearing obligation in respect of OTC equity derivatives transactions, but it is expected that such a requirement will come into force in future under EMIR for certain types of OTC equity derivatives transactions.

For requirements relating to exchange-traded equity derivative transactions, see question 24.