Frontloading

The European Securities and Markets Authority (ESMA) sent a letter to the European Commission (the Commission) on 8 May 2014 notifying the Commission of issues that it has identified regarding the frontloading requirement under Regulation (EU) No 648/2012 on OTC derivatives, central counterparties and trade repositories (EMIR).

Frontloading requirement

Under frontloading, users of OTC derivatives transactions may be required to clear transactions that are entered into after a central counterparty has been authorised to clear transactions of that class.

Issues identified by ESMA

ESMA has identified that the frontloading requirement “may introduce significant uncertainties in the market with the consequences mainly borne by derivatives end users. These consequences are legal, operational and financial… and the over-all effect could well be a reduction in the incentive to hedge risks during a certain period (to avoid the consequences of the frontloading effect), which would in turn increase the un-hedged risks and would impact negatively on financial stability”.

The period during which frontloading is relevant can be divided into two separate periods:

  • the period between (the date on which classes of OTC derivatives transactions are notified as being subject to central clearing and the entry into force of the regulatory technical standard on the clearing obligation (RTS) (not yet in force) (Period A)
  • the period between the entry into force of the RTS and the date of application of the clearing obligation (Period B).

ESMA’s view is that the uncertainties and negative impacts of the frontloading requirement are most acute during Period A as users of derivatives will not know:

  • whether the notified classes of OTC derivatives transactions will be subject to central clearing;
  • when the clearing obligation will take effect for the relevant classes of OTC derivatives transactions; or
  • which central counterparties will be available for clearing the relevant classes of OTC derivatives transactions.

At the start of Period B these uncertainties will no longer be present.

ESMA’s proposal

ESMA has suggested that the frontloading requirement should not apply to transactions that are entered into during Period A and should only apply to transactions entered into during Period B.

There will be a consultation at a later date regarding the parameters that will determine which transactions entered into during Period B will be subject to the frontloading requirements.

ESMA has written to the Commission as the European Parliament and the Council have a right of objection to regulatory technical standards. ESMA has requested the thoughts of the Commission on an urgent basis as ESMA received the first notification that a central counterparty has been authorised under EMIR on 18 March 2014.

ESMA Q&A

On 21 May 2014, ESMA published its updated Q&As on the implementation of EMIR. The additional Q&As are relevant to the following areas:

  • the application of EMIR to alternative investment funds
  • intra-group exemptions
  • treatment of non-EU non-exempt central banks
  • segregation, portability and central counterparty organisational requirements.