Which derivatives are subject to mandatory clearing?
On 10 June 2016, the European Commission made a third mandatory clearing determination under EMIR. Once it has passed scrutiny by the European Parliament and Council, the relevant delegated regulation will extend mandatory clearing to the interest rate swaps ("IRS") set out in the annex. This includes certain fixed-to-floating interest rate swaps and forward rate agreements denominated in the following currencies:
- Norwegian Krone (NOK);
- Polish Zloty (PLN); and
- Swedish Krona (SEK).
The first mandatory clearing determination introduced the clearing obligation to certain IRS in G-4 currencies, which will be phased in from 21 June 2016. The second extended the obligation to certain credit default swaps, which will be phased in from 9 February 2017 (see our earlier update).
When does the clearing obligation take effect for these IRS?
The determination will take effect 20 days after its publication in the Official Journal of the EU (the "Commencement Date"), after which the obligation to clear these IRS will take effect as follows:
- Category 1 (clearing members for at least one of the classes of OTC IRS subject to clearing): 6 months after the Commencement Date.
- Category 2 (financial counterparties ("FCs") and alternative investment funds ("AIFs") that exceed a threshold of Euro 8 billion aggregate month-end average outstanding gross notional amount of all non-centrally cleared derivatives for January, February and March 2016 (the "Threshold")): 12 months after the Commencement Date.
- Category 3 (FCs and AIFs that are not clearing members and that do not exceed the Threshold): 18 months after the Commencement Date.
- Category 4 (non-financial counterparties whose rolling average position over a 30 working day period in OTC derivatives (net of their commercial and treasury financing hedges) exceeds a relevant clearing threshold (known as an NFC+)): 3 years after the Commencement Date.
We will republish this Alert once the determination has been published in the Official Journal and the Commencement Date and other consequent dates are known. Please see our earlier Technical Update for further details on counterparty classification.
Where an IRS is entered into between two counterparties in different categories, the date from which the clearing obligation takes effect for that contract will be the later of the two dates applicable to the counterparties.
There is a temporary three year reprieve for intra-group derivative transactions between an EU FC and a third country entity which would be an FC if established in the EU, without the need for an equivalence decision by the Commission in respect of the third country (provided that all the other conditions of the intra-group exemption are met). This three year reprieve may be cut short if the Commission subsequently makes an equivalence decision for the third country prior to the end of the three year period.
Consequences of failing to clear
Member States can apply their own rules on penalties for a counterparty breaching the rules in EMIR. The UK Financial Conduct Authority has the power to impose unlimited fines and to issue a public warning.
Margin for non-cleared trades
Although it seems that the phasing in of mandatory clearing is gathering pace, the same momentum has not been displayed in relation to the initial and variation margin requirements for non-cleared derivatives entered into between qualifying counterparties (i.e. FCs and NFC+s) (see our previous update). These rules were expected to be phased in from 1 September 2016, starting with the initial margin requirements for trades between the most active qualifying counterparties.
The Commission is, however, yet to finalise the rules and it now appears that it will not be in a position to do so before the end of 2016, with a view to the initial margin rules being phased in from around the middle of 2017. Other prospective dates, including those for the introduction of the variation margin requirements, are also expected to change, although it is not yet clear what the revised dates will be.
This delay may not signal a reprieve for the largest EU derivatives counterparties, as they may still be caught by rules in other jurisdictions (for example, when they trade with counterparties in the US, as the US margin rules are currently still expected to apply from 1 September 2016).
Looking ahead, in the absence of global "equivalence decisions" or "substituted compliance determinations", there is a risk that derivatives counterparties will be subject to two different margin regimes in relation to the same derivatives contract (for example, when an EU counterparty trades with a US counterparty).