Counterparties will be required to clear all OTC derivatives of a class which has been declared subject to the clearing obligation that are concluded between:
- Two financial counterparties
- A financial counterparty and an in-scope non-financial counterparty
- Two in-scope non-financial counterparties
- A financial counterparty or an in-scope non-financial counterparty and a third country entity that would be subject to the clearing obligation if it were established in the EU.
It may also apply to a derivative concluded between two third country entities that would be subject to the clearing obligation if they were established in the EU, provided that the contract has a direct, substantial and foreseeable effect within the EU or where such obligation is necessary or appropriate to prevent the evasion of EMIR. Power has been delegated to the Commission to specify which contracts would be considered to have such effect or be necessary or appropriate for such purposes.
Which derivatives must be cleared?
The Commission will decide which classes of OTC derivatives must be cleared and ESMA will keep a register which will show, in relation to each class, which CCPs are permitted to clear the derivatives and the date from which the derivatives must be cleared. There are two ways in which a derivative may be added to the list:
Bottom up: This is where a competent authority authorises, or ESMA recognises, a CCP to clear a class of OTC derivatives. In this case, the competent authority will notify ESMA, which will, having conducted a public consultation and consulted the European Systemic Risk Board and any appropriate third country competent authorities, determine whether that class of derivatives should be subject to the clearing obligation, the date from which the obligation should take effect and the categories of counterparty to which the obligation applies, and the minimum remaining maturity of any OTC contracts that are required to be cleared even though they were entered into before the clearing obligation took effect. ESMA must take into consideration various criteria including the degree of standardisation, volume and liquidity of the relevant class of derivatives and the availability of fair, reliable and generally accepted price information. ESMA may also take into consideration the inter-connectedness between counterparties using the relevant class of derivatives and the anticipated impact of counterparty credit risk and the impact on competition within the EU.
Top down: This is where ESMA identifies on its own initiative, having undertaken the same consultations and taken into consideration the same criteria, classes of derivatives that should be subject to the clearing obligation and notifies the Commission. The Commission may ask ESMA to publish a call for the development of proposals for the clearing of any such class of derivatives.
Are there any exemptions?
Certain intra-group transactions do not have to be cleared. Intra-group transaction has a different meaning for financial and non-financial counterparties but the basic requirements are that they are entered into with another counterparty which is part of the same group where the counterparties are included in the same consolidation on a full basis, are subject to appropriate centralised risk procedures and are established in the EU or third country which the Commission has found to impose equivalent obligations. In relation to a financial counterparty, the counterparty must also be a financial counterparty or one of certain other types of entities. It is likely that the exemptions will be subject to authorisation of their application by the relevant competent authorities.
There is also a transitional provision which means that the clearing obligation will not apply to OTC derivatives that are objectively measurable as reducing risks directly related to the financial solvency of certain defined pension scheme arrangements for three years after the entry into force of EMIR. This will be the subject of a review but may be extended twice for a total period of a further three years if the Commission considers that technical solutions for the transfer of non-cash collateral as variation margin have not been made and the adverse effect of CCP clearing derivatives on the retirement benefits of future pensioners remains unchanged.
The clearing obligation applies to derivatives that are entered into or novated on or after the date from which the clearing obligation takes effect or an earlier date to be determined by the Commission. This means that clearing members and clients will have to submit not only new OTC derivatives but also those that exist at the time the clearing obligation takes effect.
A non-financial counterparty will be permitted a grace period from when it comes within scope to clear all relevant future contracts.
Where can OTC derivatives be cleared?
OTC derivatives must be cleared through a central counterparty that has been authorised or recognised to clear the relevant class of derivatives pursuant to EMIR as listed in the register to be maintained by ESMA. EMIR sets out the process by which CCPs established in the EU will be authorised and those established in a third country will be recognised.
Beneficial treatment of exposures to a CCP for credit risk capitalisation purposes will continue but on a more limited basis. Under changes proposed by the Basel Committee on Banking Supervision (BCBS), margin posted to a CCP which complies with the Committee on Payment and Settlement Systems - International Organisation of Securities Commissions International Principles for Financial Market Infrastructures (a qualifying CCP) in such a way that it is bankruptcy remote from the CCP will receive a risk weighting of 0 per cent, whereas collateral posted to such a CCP will otherwise be risk weighted at 2 per cent. If the CCP does not qualify under the Principles, the clearing member will have to capitalise its margin as under the bilateral framework, which would mean a risk weighing of at least 20 per cent for a CCP which is a bank and 100 per cent for a CCP which is a corporate financial institution.