Clearing in Europe for Interest Rate Swaps is Coming
ESMA has now issued its final draft regulatory technical standards (RTS) that define the scope of interest rate swaps that must be cleared under European Markets Infrastructure Regulation (EMIR). Before applying, the RTS must be formally adopted and published*. This is expected to take place at some point in Q1 2015. The RTS will “enter into force” 20 days after they are published.
Mandatory clearing will be phased by type of counterparty. ESMA has proposed four categories. Assuming the RTS are formally adopted and published in Q1 2015, counterparties, including buy-side firms, who are direct clearing members will be classed as category 1, and will be required to start clearing in Q3 2015.
Institutional clients who are designated as category 2 counterparties are expected to start clearing by Q1 2016, and from Q3 2016 for category 3. EMIR mandatory clearing also applies to certain non-financial counterparties; it is expected that this will apply from Q1 2018.
* Note: This information is based on ESMA’s final draft RTS. There are ongoing discussions between EU policy makers about certain aspects of the RTS. Therefore, it is possible that there could be further changes before the RTS are formally adopted and published.
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All of the above instruments are limited to:
• Single currency settlement
• No optionality
• Constant or variable notional amounts
The EMIR clearing scope is almost identical to the CFTC’s US clearing mandate. The only exceptions are:
• 3D-3Y JPY FRA have a clearing mandate in the US but not under EMIR
• OIS in EUR, USD and GBP with a tenor of up to 3Y are mandatorily clearable in the EU, whereas the US mandate covers tenors up to 2Y
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CALCULATION OF ACTIVITY THRESHOLD FOR CATEGORIES 2 AND 3
Counterparties whose aggregate month-end average notional amount of non-cleared derivatives in the three months before the RTS enter into force is above €8 billion will be in category 2. Counterparties who fall below this threshold will be in category 3.
WHAT IS FRONTLOADING?
Frontloading is the requirement to centrally clear certain derivatives contracts entered into before the clearing obligation for the counterparty takes effect. Under ESMA’s final draft RTS, the main frontloading window would open after the formal adoption and publication of the RTS. ESMA has set out a minimum remaining maturity for each class of derivatives, which will have the effect of excluding certain contracts from the frontloading requirement.
The main frontloading requirement will apply to uncleared contracts entered into by counterparties in categories 1 and 2 following the formal adoption and publication of the RTS. Contracts that are close to expiring when the counterparty’s clearing obligation takes effect will be excluded from frontloading. Frontloading for category 3 counterparties is expected to apply only in very limited circumstances. NFC+s are not subject to frontloading.
Because of the different application of frontloading for categories 2 and 3, it will be important to establish which category you and/or your clients fall into before the front loading window opens.