Central clearing set to start in Europe but should the derivatives industry expect fits and starts?
Although the European Securities and Markets Authority (ESMA) finally inked a firm date in the diary for the clearing of interest-rate derivatives, which account for just over 80% of the $630 trn OTC market in Europe, this does not mean that the end is nigh for the OTC reform that was started in 2009. It is a step in a very long process and if the past is anything to go by, many fits and starts are expected in the future.
Under the latest decree, 21 June 2016 – two months later than expected – will see the largest banks embarking on centrally clearing plain vanilla interest rate derivatives, float-to-float swaps – known as basis swaps, forward rate agreements and overnight index swaps denominated in euro, sterling, yen or certain kinds of US-dollar denominated swaps. However, the whole process will be phased in over three years to allow additional time for smaller market participants to prepare for compliance, according to the European Commission.
This means that those in category two- financials and alternative investment funds (AIFs) above a threshold of non-cleared OTC derivatives – will have an additional six months to prepare while financial counterparties and AIFs with a low level of activity in un-cleared derivatives will have until 21 June 2017 to get ready. Meanwhile, the last group which include non-financial counterparties whose OTC derivative portfolios exceed an asset-specific threshold, do not have to be at the starting line on 21 December 2018.
Europe is not alone in missing the original deadline of 2012 set for implementation the G20 reforms agreed six years ago. Most countries have missed it due to difficulties and delays in transforming the recommendations into practical laws. However, the region is far behind the US and Japan, both of which began enforcing mandatory clearing more than two years ago.
Despite the welcome news of the new deadline, market participants see several stumbling blocks on the road for a smooth implementation, most notably the year long delay to MiFID which now only waiting for the approval of the European Council. The legislation is key because it is responsible for creating Organised Trading Facilities (OTFs) to fulfil the G20’s requirement for the electronic trading of all standardised OTC derivative contracts.
In addition, other asset classes need to be brought into the fold. For example, the European Commission has yet to endorse a requirement that off-exchange traded index credit default swaps and interest rate swaps for non-EU currencies must also be cleared.
