In September 2009, G20 leaders agreed in Pittsburgh that:

"All standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest. OTC derivative contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements."

Clearly, Europe will not meet the G20 targets by the end of this year. What is emerging is a complicated patchwork. Some obligations are likely to be in force at some point in 2013 and others some time after. Overlay this with a similar picture in the US, and keeping track of regulatory changes has become the day job of those who used to be ISDA lawyers.

The European Markets Infrastructure Regulation (EMIR) has been in force since 16 August this year. However, several implementing rules are needed for the obligations in EMIR to have effect.

Clearing. For mandatory clearing, there has to be:

  • an authorised Central Counterparty (CCP) whose regulator has told the European Securities and Markets Authority (ESMA) of its intent to clear products; and
  • an implementing measure prescribing the contracts and the parties who have to clear them.

Our best guess is that mandatory clearing will apply to interest rate swaps for the sell side only, and no earlier than Q4 2013.

Reporting. ESMA has publicly stated that it is not keen to act as trade repository. However, it is unlikely that any commercial trade repository will be authorised by ESMA before 1 April 2013. The earliest reporting start date would then be 90 days after trade repository authorisation: some time in Q3 2013 for credit derivatives and interest rate derivatives, and for other derivatives possibly 1 January 2014. Although the reporting start dates are later than expected, the obligation is back-loaded. Parties must keep records of all trades outstanding on and after 16 August 2012. Trades still open on a reporting start date will have to be reported within 90 days of that date, and those closed before the reporting start date, three years after that.

Operational risk mitigation for bilateral derivatives contracts. ESMA’s Final Draft Technical Standards on operational risk mitigation – covering subjects such as confirmation timetables, reconciliation, portfolio compression and daily marking to market – were more forgiving on standards for implementation than the consultation paper. So, for example, the timings for confirmations are to be phased in, with the shortest – one business day – applying to interest rate swaps concluded on and after 1 March 2014.

Prudential risk mitigation for bilateral derivatives contracts. ESMA and the other European Supervisory Authorities asked for an extension on prudential risk mitigation. They wish to align European proposals on initial and variation margin and other prudential topics with those put forward by IOSCO. This, and the delay in the implementation of the Capital Requirements Regulation (CRR), make it difficult for firms to assess the exact size of the prudential cost of not clearing. What is certain is that cleared trades will be significantly more favourably treated than non-cleared trades. Initial indications are that the capital cost associated with an unsecured bilateral swap for a bank on the standardised approach to risk weighted exposures may be up to seven times higher than that of an equivalent cleared trade with a CCP. This is because the CRR proposes risk weights to CCPs of 2 per cent; and the credit valuation adjustment – an extra charge to cover credit quality weakening rather than default – does not apply to cleared trades.

Trading. EMIR does not deal with the trading obligation. That is embedded in new MiFID, and still the subject of debate. It is unlikely to be in place before the end of 2014.

Law stated as at 27 November 2012