The European Commission on 7 December put forward new proposals on clearing, corporate insolvency and company listing to make EU capital markets more attractive.
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What are central counterparties (CCPs)?
A central counterparty (CCP) is an entity that reduces systemic risk and enhances financial stability by standing between the two counterparties in a derivatives contract (i.e. acting as buyer to the seller and seller to the buyer of risk). A CCP’s main purpose is to manage the risk that could arise if one of the counterparties defaults on the deal. Central clearing is key for financial stability by mitigating credit risk for financial firms, reducing contagion risks in the financial sector, and increasing market transparency.
What is the Commission proposing?
Today’s proposal amends the European Market Infrastructure Regulation (EMIR) and makes targeted amendments to the prudential frameworks for banks (the Capital Requirements Regulation, the Capital Requirements Directive) and for investment firms (the Investment Firms Directive) as well as to the Undertakings for Collective Investment in Transferable Securities (UCITS) Directive and the Money Market Funds (MMF) Regulation.
The aim of today’s package is:
- To encourage clearing in the EU and to improve the attractiveness of EU CCPs by simplifying the procedures for CCPs when launching new products and changing risk models. It does so by introducing a non-objection approval for certain changes that do not increase the risks for the CCP. This will allow EU CCPs to offer new products for clearing and introduce model changes more quickly, therefore making EU CCPs more attractive, while ensuring adequate risk considerations are upheld and without endangering financial stability. For example, a CCP would like to request an extension of services to add a new EU currency to a class of financial instruments already covered by its existing authorisation. In the past, it would have needed to go through a full authorisation process (taking between months and up to two years in certain cases). Under today’s proposal (for the non-objection procedure), the CCP will be informed within 10 working days if the competent authority objects to such extension.
- To make EU CCPs more resilient and to draw the lessons from recent developments in energy markets by further enhancing the existing supervisory framework. This will ensure risks to the EU’s CCPs continue to be mitigated in light of new challenges and that the EU’s central clearing system continues to be able withstand economic shocks.
- To strengthen EU open strategic autonomy and safeguard financial stability by requiring clearing members and clients to hold, directly or indirectly, an active account at EU CCPs, and reduce excessive reliance on systemically important third-country CCPs.
Why is the proposal needed?
Today’s package aims to improve the central clearing system in the EU, making EU CCPs more efficient and attractive. It addresses the vulnerabilities that stem from the current excessive reliance on certain third-country CCPs deemed to be substantially systemic for the EU, ensuring that the EU has a competitive and efficient clearing system that is safe and resilient.
The Commission, as well as the European Securities Markets Authority (ESMA), have previously expressed concerns about the possible financial stability risks associated with the excessive reliance of EU financial markets on a few CCPs based in the UK. The Commission has repeatedly invited market participants to reduce their excessive reliance to such CCPs.
In addition, the energy crisis has affected the real economy in the EU and had ramifications on certain areas of financial markets, including clearing. This crisis brought to light the difficulties certain energy firms are facing in order to meet CCP margin calls.
What impact will it have?
Overall, the proposed measures will have a positive impact by:
- improving the attractiveness of EU CCPs;
- safeguarding EU financial stability in the EU and in a cross-border context, reducing the excessive reliance on third-country CCPs; and
- ensuring safe, robust and competitive post-trade arrangements, in particular central clearing, further strengthening CMU and contributing to deep and liquid EU capital markets.
EU CCPs will benefit from being able to quickly bring new products to the market and consequently meeting the demands for new clearing offers by clearing members and clients. In addition, they will be able to adapt the models they use to measure the risks they face more quickly, allowing a timely management of such risks.
Clearing members (mainly banks) will benefit from extended, faster clearing offers by CCPs, thereby providing more choices on where to clear.
Clients such as non-financial corporates or financial market participants – will benefit from:
- more transparency on margin models and collateral requirements;
- information on where to clear certain contracts that can be cleared both at a third-country CCP and at an EU CCP; and
- the possibility to use bank and public guarantees.
What will be the impact for corporates?
Corporates will benefit from the measures aimed at making central clearing safer, including:
- the proposed measures to increase the transparency of CCPs’ margin calls will make it easier to predict margin calls and prepare how to meet such requests.
- the provisions concerning the calculation of the clearing thresholds will be reviewed to take into account the concerns expressed in the past months by firms, in particular firms active in commodity derivatives, to better reflect, where needed, different types of commodities, and should improve their situation in terms of the clearing thresholds without endangering financial stability.
At the same time, corporates will need to meet robust requirements if they want to become direct clearing members at a CCP, as the lack of intermediation by a financial firm such as a bank could leave them exposed to liquidity risks due to collateral requirements that can be volatile in a stressed situation.
In addition, corporates will be subject to reporting requirements related to their intragroup trades, to allow authorities to have a comprehensive picture of their activities as proposed by ESMA in its recent letter to the Commission.
What are the elements of the package that respond to the energy crisis?
The package includes the following main measures to improve the framework following the recent energy crisis:
- improved transparency of CCPs’ margin models;
- improved CCP participation requirements to be met by corporates;
- broadening of CCP eligible collateral to include public guarantees and bank guarantees;
- reporting requirements on the intragroup derivative exposures of corporates;
- improved calculation and review of the clearing thresholds;
- greater consideration of the impacts of intraday margin calls by CCPs and greater focus on avoiding procyclical collateral haircuts;
- revision of the hedging criteria to ensure they remain appropriate in light of market developments.
What will happen to firms that are under the clearing obligation?
Under the proposal to amend EMIR, firms subject to the clearing obligation will be required to clear at least a portion of certain systemic derivatives through active accounts at EU CCPs. Such derivatives refer to the types of derivatives identified by ESMA in their report (ESMA report on UK CCPs, 2021) issued last year, as of substantial systemic importance to the EU or to one or more Member States, under Article 25 (2c) of EMIR. The specific derivatives are the following:
- Interest rate derivatives denominated in euro and Polish zloty
- Credit default swaps
- Short-term interest rate derivatives denominated in euro
The requirement to clear such specific derivatives in an EU CCP can be met via accounts opened directly at an EU CCP or indirectly through a clearing member, depending on the clearing arrangements in place and will be further specified through regulatory technical standards.
It is expected that firms subject to this requirement will have to bear some costs, due to the loss of some netting benefits, reduced collateral optimisation and some (limited) additional operational costs due to maintaining several accounts in the EU and in third-country CCPs. At the same time, several EU market participants already have accounts at CCPs in the EU, so the additional costs for them would be negligible.
To take those potential impacts into account, the proposal envisages:
- First, to ensure a proper calibration of the levels of activity that will be required in the EU active accounts and an effective outcome that also minimises the cost for the entities subject to the obligation.
- Second, ESMA will need to calibrate the required level of activity, taking into account the possible impacts on competitiveness of EU market participants and the need for an effective, yet balanced and proportionate, level of activity.
How does the active account requirement work?
All financial and non-financial counterparties subject to the clearing obligation under EMIR will be required to hold accounts, directly or indirectly, at CCPs established in the EU. They will need to clear there at least a certain portion of the derivative contracts that were identified by ESMA as of substantial systemic importance for the financial stability of the EU or one or more of its Member States.
How does the active account requirement take into account the impact on the competitiveness of EU market participants?
The Commission proposal seeks to ensure that the calibration of the minimum level of clearing activity that needs to be maintained in accounts at EU CCPs is proportionate and can be adapted to changing circumstances.
In this regard, ESMA in cooperation with the EBA, EIOPA and the ESRB, and after having consulted the European System of Central Banks, is entrusted with developing draft regulatory technical standards specifying the details of the level of substantially systemic clearing services to be maintained in the active accounts in EU CCPs.
In doing so, ESMA should consider the costs, risks and the burden such calibration entails for banks and corporates, the impact on their competitiveness, and the risk that those costs are passed on to other firms acting as clients in the market. In addition, suitable phase-in periods for the progressive implementation of the requirement to hold a minimum level of clearing activity in the accounts at EU CCPs, should be foreseen.
Where ESMA undertakes an assessment under Article 25(2c) of EMIR and concludes that certain services or activities of a Tier 2 CCP are of substantial systemic importance, or that services or activities that were previously identified no longer are, the Commission is empowered to adopt a delegated act to amend the list of derivative contracts subject to the requirement accordingly.
Is this a relocation policy?
No. This is an issue of financial stability. According to the ESMA report on UK CCPs (2021) the amount of derivatives cleared in two UK CCPs are of such substantial systemic importance that they could pose a risk to the financial stability of the EU, or to one of its Member States.
As it is designed to address the specific risks identified, the requirement does not imply that all clearing should be repatriated to the EU. It covers only a portion of the relevant activities and does not forbid clearing in other jurisdictions.
Why is the Commission changing certain provisions concerning equivalence?
The proposal entails two different aspects related to the equivalence framework under EMIR.
First, the Commission simplifies the framework for intragroup transactions. It provides more legal certainty to market participants and our international partners by deleting the condition of an equivalence decision to benefit from intragroup exemption. In order to benefit from the intragroup exemption, entities located in third countries should be in a country that is not identified as having deficiencies in terrorist financing and anti-money laundering regulations, or considered as a non-cooperative jurisdiction for tax purposes. The country should also not have been identified by the Commission based on legal, supervisory and enforcement arrangements with regard to risks, including legal and counterparty credit risks.
Second, the proposal introduces the possibility for the Commission to take a more proportionate approach when adopting an equivalence decision for a third country by waiving the requirement to have an effective equivalent system for recognising third-country CCPs. This will be possible only when it is deemed to be in the interests of the Union and particularly when the risks involved in clearing in that third country are low.
When will the new rules become applicable?
Once adopted, the proposals will both start to apply immediately.
Changes to the prudential rules for insurance and reinsurance companies will take the form of a Delegated Act.
Source: European Commission
