Legally and politically important
Cleared from scrutiny; drawn to the attention of the Treasury Committee
Proposal for a Regulation on the clearing obligation, the suspension of the clearing obligation, the reporting requirements, the risk-mitigation techniques for OTC derivatives contracts not cleared by a central counterparty, the registration and supervision of trade repositories and the requirements for trade repositories
Article 114 TFEU; ordinary legislative procedure; QMV
(38703), 8890/17 + ADDs 1—3, COM(17) 208
6.1Over-the-counter (OTC) derivatives play a major role in financial markets. They include many types of relatively straightforward currency or interest rate hedges (used by many non-financial businesses to manage the risk of exchange or interest rate fluctuations). However, there are also highly-complex transactions credit default swaps– usually entered into by larger financial institutions—which aim to protect one counterparty in a contract against a default by the other. The latter derivatives in particular were one of the drivers of the 2008 financial crisis, when unsustainable exposures to such poorly-understood financial flows contributed to the collapse of Lehman Brothers in September 2008, which in turn weakened American insurance group AIG to the point where it needed an unprecedented bail-out from the US Government in September that same month.
6.2As a result, as part of a wider international effort, the EU enacted legislation in 2012 to tighten up supervision of the market for OTC derivatives and bring greater transparency to the market to identify build-ups of risk. These rules are set out in the , known usually by its acronym EMIR. This legislation requires many derivatives trades that involve an EU-based counterparty to be ‘cleared’ by a regulated Central Counterparty (CCP), which steps in to fulfil the obligations of a counterparty which defaults on the contract so that there is no chain reaction of bankruptcies. In addition, derivatives trades need to be reported to a trade repository to give regulators insight into the market. UK is a leading global centre for the clearing industry, with its three major Central Counterparties—in particular LCH.Clearnet, owned by the London Stock Exchange—handling 75 per cent of centrally-cleared euro-denominated interest rate derivatives.
6.3In May 2017, the European Commission proposed to EMIR with respect to the clearing and reporting obligations incumbent on counterparties in derivatives trades. In particular, its review of the existing 2012 Regulation had found that some of the requirements were disproportionate for non-financial institutions that enter into derivatives trades (for example companies using currency swaps). It therefore proposed amendments (colloquially known as “EMIR REFIT”), which would—broadly speaking—reduce the administrative burden imposed by the Regulation on certain financial market participants not considered a risk to overall financial stability. These changes would, however, need to be agreed jointly by the European Parliament and the EU’s national governments under the ordinary legislative procedure. (In parallel, the Commission also to the way CCPs active within the EU are supervised by public regulators, including those CCPs based outside of the Union. We will be considering the state of play on those proposals separately in the near future, as agreement on them has also been reached and they are particularly relevant to the British clearing industry after Brexit.)
6.4After nearly two years of negotiations, the Economic Secretary to the Treasury (John Glen MP) on 19 March 2019 that the Parliament and the Member States had reached . The new Regulation will exempt more (smaller) financial counterparties and non-financial counterparties from certain clearing and reporting obligation. An existing exemption from the clearing requirement for pension schemes will also remain in place for a further two years. The Commission would also have the power to suspend the clearing obligation for specific types of derivatives in “exceptional situations”, for example where the only CCP offering the requisite clearing service ceases trading. EMIR REFIT will also introduce a new legal obligation on clearing brokers to provide services on “fair, reasonable, non-discriminatory and transparent commercial terms” (“FRAND”), by requiring transparency on fees as well as “unbiased and rational contractual arrangements”.
6.5Under article 2 of the amending Regulation, the changes to the clearing and reporting obligations under EMIR will mostly be in effect from spring 2020, provided formal adoption takes place before the summer of 2019. The major exceptions would be the provisions relating to conflicts of interest between trading and clearing units of CCPs, and new requirements on the verification and transfer of data held by trade repositories (which would instead become applicable in early 2021). The European Commission will need to adopt a series of regulatory and implementing technical standards to give full effect to the changes, for example on data standards, the segregation of client collateral from the assets of the Central Counterparty, and transfers of information held by trade repositories.
6.6The new rules will also eventually form the regulatory baseline for ‘equivalence’, the legal mechanism by which the Commission can assess whether a non-EU country has a comparable supervisory approach to derivatives trades as EMIR (and under which it can grant market access rights comparable to those enjoyed by CCPs and trade repositories based in the EU itself). This is the route by which British Central Counterparties will need to access the European market after the UK leaves the EU Single Market.
6.7The UK notified the European Council of its intention to withdraw from the EU under Article 50 TEU on 29 March 2017. The extent to which the changes brought about by “EMIR REFIT” will apply directly in the UK as a matter of EU law is dependent on the next steps in the Brexit process, and in particular on the date the UK actually ceases to be a Member State and on whether the House of Commons ratifies the draft Withdrawal Agreement published in November 2018:
6.8In any scenario where the UK is still subject to EU law when the “EMIR REFIT” legislation takes effect, the new rules would apply to the UK financial services industry in its entirety from its entry into force until EU law ceased to have supremacy. The Economic Secretary, in his latest update on the proposal, does not refer to the implications of the new legislation for the UK during either the transitional period or an extended Article 50 period. His letter does, however, note that the Government is “broadly supportive” of the compromise text that has emerged. With the European Parliament due to approve the legislation at its final Plenary Session before the EU elections in April 2019, it is expected the changes to EMIR will be formally voted on by the Member States in the Council in the coming months. The Minister has therefore requested the Committee to clear the proposal from scrutiny, to enable the Government to “vote in favour […] should a vote take place prior to the UK’s departure from the EU”.
6.9In a ‘no deal’ scenario, where the Article 50 period is not extended further and the Withdrawal Agreement is not ratified, “EMIR REFIT” would not apply in the UK directly as a matter of EU law. However, the Treasury is seeking powers under the Financial Services (Implementation of Legislation) Bill to implement the new rules in domestic law by means of regulations in a ‘no deal’ scenario to ensure the competitiveness of the UK’s financial services sector. To preserve EU market access for British CCPs in this scenario, the Government would need to obtain ‘equivalence’ under EMIR (see paragraph 6).
6.10We have set out our assessment of the new EMIR Regulation for the UK in various Brexit scenarios in more detail in our conclusions below.
6.11We thank the Economic Secretary for this latest update on the negotiations to revise the clearing and reporting obligations for derivatives trades incumbent on financial and non-financial institutions under EMIR. Given the UK’s pre-eminent position in the global clearing industry, and its close economic links with the EU, it is likely to have significant repercussions for the British financial services industry irrespective of the UK’s decision to leave the European Union.
6.12We note in this respect that, while the UK is now due to formally leave the EU on 12 April 2019 (or at an even later date, if the Article 50 period were to be extended further), the draft Withdrawal Agreement which the Government negotiated would establish a transitional period after the formal date of ‘EU exit’. During this time, the UK would stay in the Customs Union and Single Market (avoiding immediate economic dislocation and providing time for the two sides to begin negotiating a new trade agreement). However, EU legislation would continue to apply in the UK as if it were still a Member State. That would extend to European laws agreed after UK withdrawal, provided they take effect during the transition. Similarly, if the Article 50 period is extended again by mutual agreement between the UK and the EU, the UK would remain a full Member State until the end of that extension, and be subject to the supremacy and direct effect of EU law for its duration.
6.13Given that the EMIR REFIT legislation is due to be adopted in spring 2019 and take effect in stages (with the bulk of the changes having force of law from early 2020), it is therefore clearly a possibility that this new European legislation will apply directly to British CCPs, trade repositories and their customers until the UK had fully left the Single Market. We therefore welcome the Treasury’s assessment that the final agreement on the Regulation is acceptable to the Government.
6.14However, we note with concern that the REFIT amendments delegate responsibility to the European Commission for a number of technical standards to give full effect to the regulatory changes for the derivatives trade: during any transition, when the UK is no longer a Member State but still subject to EU law, those will be discussed and approved without the input of the Treasury, the Bank of England or the Financial Conduct Authority. The Government would also not have a vote if the new suspension mechanism for the clearing and reporting obligation were to be triggered during the transitional period, since such a suspension must be approved as an Implementing Act by a qualified majority of EU Member States only. During any further extension of the Article 50 period, the UK would remain a full Member State with the attendant representational and voting rights it currently enjoys in the Council of Ministers and associated bodies.
6.15Even after EU law ceases to apply directly in the UK—for example, beyond the end of the transition, or in a ‘no deal’ scenario where the Withdrawal Agreement is not ratified—the amendments to the EMIR Regulation would remain important. Once it leaves the Single Market, British CCPs and trade repositories will lose their automatic right to operate throughout the EU. Instead, to continue servicing EU-based customers, a number of conditions need to be fulfilled:
6.16Whether in the short-term (a no-deal scenario) or the medium-term (ratification of the Withdrawal Agreement), ‘equivalence’ will become the mechanism by which UK-based CCPs and trade repositories can access the European market from their British base. We therefore welcome the EU’s decision in December 2018 to pre-emptively grant the UK equivalence for Central Counterparties under the current version of EMIR, to avoid significant market disruption in April 2019 if the ‘no deal’ scenario occurs. While the Commission has adopted further regulatory measures to facilitate the novation of uncleared transactions from the UK to an EU counterparty if the Withdrawal Agreement is not ratified, the Bank of England still has concerns about the ability of £20 trillion of uncleared derivatives to be managed in a ‘no deal’ eventuality for contracts not novated in time. We also note there is no contingency equivalence decision in place for UK-based trade repositories.
6.17Moreover, under a separate proposal amending the provisions of EMIR relating to the supervision of Central Counterparties themselves, obtaining UK-wide equivalence and CCP-specific recognition from outside the Single Market will become more difficult. Under those changes, which we will discuss more extensively in forthcoming Report, equivalence could require the Bank of England to effectively accept and enforce decisions made by ESMA in relation to British CCPs without its input. In addition, the EU is introducing a ‘location policy’ with the explicit aim of having a legal mechanism to push the UK’s largest Central Counterparty to relocate activities to the European Union after Brexit, as a means of keeping it within EMIR’s regulatory orbit.
6.18It is a cause of concern therefore that the EU’s equivalence decision for UK CCPs in a ‘no deal’ scenario is explicitly time-limited and will expire in March 2020. If the Government wants to secure continued equivalence beyond that date, or after the end of the transitional period if the Withdrawal Agreement is ratified, it would need to stay functionally aligned with EMIR—including not only the amendments described in this chapter, but also a stricter equivalence process for systemically-important CCPs referred to above—indefinitely. If an agreement on equivalence under EMIR is not found after the UK leaves the Single Market (or if the ‘no deal’ contingency measure is allowed to expire), British businesses would no longer be able to provide clearing and repository services in any EU Member State from their London base. Given the potential economic repercussions, the EU will need to be mindful of the disruption that would be triggered by shutting out British CCPs from its market.
6.19Similarly, however, any domestic policy choices in the UK with respect to clearing and reporting services for trade in derivatives would need to be balanced against the potential consequences for the ability to export such services to the EU. We note in this respect that the Treasury has pushed for the introduction of the Financial Services (Implementation of Legislation) Bill, which would give it the power to implement the changes that would be made by EMIR REFIT—and various other EU financial services proposals—by means of a statutory instrument in a ‘no deal’ scenario (i.e. when there would be no EU legal obligation to apply the new Regulation). It would be able to make regulations to do so, including “with any adjustments the Treasury consider appropriate” so long as they do not constitute a “major” deviation from the EU legislation they are meant to implement.
6.20In its Explanatory Memorandum on the Bill, the Government describes it as a “no deal” measure which will “minimise disruption” to the UK regulatory regime for financial services following exit from the EU without a Withdrawal Agreement in place. We caution the House to consider carefully how the Government may use the powers that would be delegated to it under the Bill, given that unspecified ‘adjustments’ could be made to EU law, and the test of whether any such changes are ‘major’—and therefore not allowed—would be subjective and difficult to measure in practice. We also reiterate our concern that the Government’s reliance on equivalence with EU law to access Europe’s market for financial services after Brexit could also constrain the UK’s regulatory autonomy in the longer term, with potentially unforeseen consequences.
6.21We are content to now clear the EMIR REFIT proposal from scrutiny, in view of its imminent adoption by the Council and the Government’s support for the new legislation. However, as described above, there are many outstanding issues created by Brexit with respect to the impact EU financial services legislation will have in the UK beyond ‘exit day’. We therefore draw these developments to the attention of the House, and of the Treasury Committee in particular.
Proposal to amend Regulation (EU) No 648/2012 as regards the clearing obligation, the suspension of the clearing obligation, the reporting requirements, the risk-mitigation techniques for OTC derivatives contracts not cleared by a central counterparty, the registration and supervision of trade repositories and the requirements for trade repositories: (38703), + ADDs 1–3, COM(17) 208.
6.22An over-the-counter (OTC) derivative is privately negotiated, and not traded on an exchange. They account for almost 95% of the derivatives market. The size of the market is enormous: in the first half of 2018, the notional outstanding amount of OTC derivatives was nearly $595 trillion trillion (£460 trillion). However, the financial crisis highlighted deficiencies within the market, with major implications for financial stability. The first deficiency was counterparty credit risk: the default of a major participant in the OTC market can have systemic implications, requiring Government intervention. The second was transparency, as neither market participants nor regulators had sufficient oversight of exposures in the OTC market, causing unwillingness to trade in stressed markets and restricting liquidity.
6.23To address these issues, in 2009 G20 leaders agreed the Pittsburgh Declaration. It stipulated that all standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms and cleared through central counterparties, by the end of 2012 at the latest. Central counterparties (CCPs) act as a safety mechanism in the OTC market, placing themselves in the middle of every sale: they effectively become the buyer to every seller and the seller to every buyer, reducing risks of chain reactions or financial instability if either the buyer or the seller of the derivatives contract cannot fulfil their obligations. As a result, the risks of the derivatives market are concentrated in the CCPs. The G20 also called for use of non-centrally cleared contracts to be discouraged by making them subject to higher capital requirements. Leaders also agreed that all OTC derivative contracts should be reported to trade repositories, to give regulators a more comprehensive and transparent overview of the market and the build-up of financial stability risks.
6.24In response to this G20 agreement, the EU adopted the European Market Infrastructure Regulation (commonly referred to as EMIR) in 2012. EMIR:
6.25The UK plays a central role in clearing derivatives globally, as well as in the implementation of EMIR for the EU and the Eurozone. The Bank for International Settlements has stated that the UK is the single largest venue for OTC derivatives activity. Globally, UK-based CCPs account for almost half of all clearing of interest rate derivatives (which account for 80 per cent of all OTC transactions). For euro-denominated interest rate derivatives the UK is an even larger centre, clearing 75 per cent of all such transactions. There are four UK-based CCPs recognised under EMIR.
6.26In November 2016, the Commission published a report of its review of the application of EMIR, as part of its “regulatory fitness” (REFIT) process of evaluating EU legislation.
6.27This review concluded that there was general support for the core objectives of EMIR of promoting transparency and standardisation in derivatives markets and reducing systemic risk through its core requirements. It also proposed a new legislative framework for the recovery and resolution of CCPs at risk of collapse, aiming to clarify lines of responsibility and measures to mitigate any spill-over effects in the “unlikely situation” that an EU-based central counterparty had insufficient liquidity to meet its obligations. We have considered this proposal elsewhere. In addition, the Commission identified a number of areas where EMIR could be adjusted, in order to increase the efficiency of its requirements and reduce “disproportionate costs and burdens” on businesses. It said that it was considering a number of amendments to EMIR with respect to the obligations for counterparties.
6.28In May 2017, the Commission translated its review findings into a with respect to the obligations that EU law imposes on Central Counterparties, trade repositories and those who use them (colloquially referred to as ‘EMIR REFIT’). The primary objectives of the proposal were to:
6.29The Rt Hon. Stephen Barclay MP, then Economic Secretary to the Treasury, submitted an on the Commission proposal on 3 July 2017 (four months after the Government formally notified the European Council of its intention to withdraw from the EU under Article 50 TEU). In it, he noted that the Government supported the Commission proposal, but would use its examination by the Council to ensure that EMIR would remain consistent with the implementation of the 2009 Pittsburgh agreement across G20 partners, and that application of the Regulation between EU Member States would not lead to regulatory arbitrage and competitive distortions. With respect to the timetable for implementation of the REFIT proposal in the context of the UK’s withdrawal from the EU, the Minister told us at the time that the Presidency and the Commission are seeking “swift agreement on the proposal so that certain provisions come into force by summer 2018”.
6.30In parallel to the ‘REFIT’ proposal, the Commission and the European Central Bank also tabled separate draft legislation on the supervision of CCPs by public regulators. One of the core objectives of those proposals was to apply stricter regulation of non-EU Central Counterparties active on the European market. Under this separate legislation, the EU could require–as a last resort–that a CCP relocate to an EU Member State if its functioning was considered essential to the European economy. Those proposals, which are primarily targeted at London’s clearing industry after Brexit, remain under scrutiny, and we have considered them separately in a different chapter of this Report.
6.31The previous Economic Secretary (the Rt Hon. Stephen Barclay MP) in December 2017 that the Estonian Presidency was seeking a common position among the EU’s national governments, as the basis for negotiations with the European Parliament on the final substance of the EMIR REFIT proposal, by the end of 2017. In July 2018, the new Economic Secretary (John Glen MP) sent us a confirming belatedly that the Member States’ Permanent Representatives in Brussels (COREPER) had indeed adopted such a ‘’ on 19 December 2017.
6.32In terms of the substance of the Member States’ position, the Minister noted that the thrust of the Commission proposal–the removal of certain clearing and reporting obligations for certain non-systemically important companies–had been maintained. In addition, the Government secured the removal of two of the more contentious elements of the proposal (on Securitisation Special Purpose Entities and exchange-traded derivatives) from the legal text. Instead, these would made subject to a review by the European Commission at an (unspecified) point in the future.
6.33The Minister’s letter also noted that the Member States had suggested a number of other technical changes to the wording of the Regulation, for example to clarify that in case of insolvency of a CCP its own estate would be handled under national–not European– legislation, while the fate of its clients’ assets would be subject to EMIR. A proposal by the UK to exempt bundled transactions (so-called portfolio compression) from the clearing obligation was not accepted, although the European Commission will report on this issue in 2021.
6.34The European Parliament’s Economic & Monetary Affairs Committee (ECON) approved its at its meeting in May 2018, which was with amendments by the Parliament’s Plenary on 12 June. MEPs largely accepted the original Commission proposal. It also wanted to negotiate amendments to EMIR with the Member States which–according to the Parliament’s –would also give the European Securities and Markets Authority (ESMA) the power to develop draft technical regulatory standards specifying the conditions under which commercial terms for clearing services are considered to be “fair, reasonable, non-discriminatory and transparent”, to counter the possibility of conflicts of interest between a CCP’s trading and clearing units.
6.35Trilogue negotiations between the European Parliament and the Member States on the final substance of EMIR REFIT began in July 2018. Although the Treasury time that “conclusion of this file is likely to be delayed until September 2018”, negotiations proved to be far more protracted than that. On 5 February 2019, the Parliament and Council that they had finally reached an informal agreement on the EMIR REFIT proposal.
6.36The Economic Secretary to the Treasury (John Glen MP) informed us of this development by letter dated 19 March 2019. The finalised legal text is to be put to EU Finance Ministers for formal adoption in the coming months, possibly as early as April 2019. As the UK’s membership of the EU has now been extended until at least 12 April 2019, the Government may still have a vote in the Council of Ministers when the new rules are formally approved.
6.37As per the Minister’s letter, the final text of “EMIR REFIT” as agreed between the two institutions:
6.38The Member States’ suggested modifications with respect to CCP insolvency, Securitisation Special Purpose Entities and exchange trade derivatives (see paragraph 32 above) were also maintained in the final text. The European Parliament is expected to approve the new Regulation at its final plenary session before the European elections, in the week commencing 14 April 2019. Formal adoption by the Member States in the Council is expected to follow shortly thereafter.
6.39Under article 2 of the amending Regulation, the changes to EMIR will mostly be in effect from spring 2020. The major exceptions are the provisions relating to conflicts of interest between trading and clearing units of CCPs, and new requirements on the verification and transfer of data held by trade repositories (which will become applicable by early 2021). The European Commission will also need to adopt a series of regulatory and implementing technical standards to give full effect to the changes, for example on data standards, the segregation of client collateral from the assets of the Central Counterparty, and transfers of information held by trade repositories.
6.40The changes to EMIR described above are likely to be significant for the UK and its financial services industry irrespective of the Brexit scenario that unfolds in the coming weeks. We have set out our assessment of this in more detail in paragraphs 11 to 21 above.
8 The EU’s regulatory action on derivatives was driven by the G20’s , which also committed many other countries—including the US, Australia, China and Russia—to take action to address the financial stability risks posed by derivatives. However, these countries have often taken a different legal approach to the issue.
9 EMIR is contained in Regulation 648/2012.
10 The effect of the clearing obligation is to concentrate default risk with the CCP, rather than with the individual counterparties. That in turn requires strict prudential and governance requirements for CCPs, since a collapse of a Central Counterparty could have devastating effects on financial stability.
11 Commission Impact Assessment p. 48.
12 See for more information on the substance of the original European Commission proposal our .
13 See (dated 1 March 2019).
14 For example, the Minister explains that derivatives transactions between counterparties in the same corporate group, where at least one counterparty is a non-financial institution, should be exempted from having to be reported to a trade repository under EMIR.
15 The exemption for pension schemes is meant to protect savers’ retirement income from being eroded by the cost of their pension fund having to clear their transactions, as this requires posting of collateral. The two years plus one year construction is a compromise, as France and the European Parliament wanted to limit the exemption while the UK, the Netherlands and Denmark favoured extending it further.
16 Council of the EU press release, ““ (5 February 2019).
17 See the new .
18 See the ne .
19 Regulatory technical standards in EU law take the form of Delegated Acts, which can be vetoed by either the European Parliament or a Qualified Majority of Member States. Implementing technical standards take the form of Implementing Acts, which must be actively approved by a Qualified Majority of Member States (but over which the European Parliament has no say).
20 Under EMIR, CCPs and trade repositories based in an EU Member State have automatic ‘passporting’ rights to operate in any EU country from their home base. Non-EU CCPs and repositories have to qualify following an equivalence assessment.
21 The final day of the UK’s EU membership could also be different if a different date is inserted into the Withdrawal Agreement by mutual consent.
22 Under the Withdrawal Agreement, the transition would initially last until 31 December 2020. However, it could be extended by up to two years by mutual agreement between the UK and the EU.
23 See Articles 126 and 132 of the Withdrawal Agreement.
24 This would occur either when the UK’s EU membership ends and the Withdrawal Agreement has not been ratified, or on the final day of the transitional period if the Agreement is ratified.
25 The compromise agreement on EMIR REFIT was endorsed by the Member States’ Permanent Representatives to the EU (COREPER) on 6 March 2019.
26 In addition, the UK would also need to prove that its systems to combat money-laundering was equivalent to the EU’s Anti-Money Laundering Directive.
27 See the . The UK’s individual CCPs were registered with ESMA in February 2019, enabling them to continue operating beyond Brexit day in the absence of a transitional period. The necessary cooperation agreement between ESMA and the Bank of England was signed .
28 This means the derivatives trade in question was not subject to the clearing obligation under EMIR because of the lower risk of the counterparties for Europe’s financial stability, although it may still have been reportable to a trade repository.
29 The flexibility to novate uncleared derivatives contracts from the UK to an EU counterparty for a limited amount of time after Brexit is set out in Commission Regulations and . These are still being scrutinised by the Member States before they take effect.
30 See for more information the of the Bank of England of 5 March 2019, p. 6.
31 There are currently 8 trade repositories active in the EU. Four are UK-based (DTCC, UnaVista, CME and ICE TVEL), while the other three are from Poland, Luxembourg and Sweden. DTCC opened an Irish subsidiary in March 2019. The same month, a fifth UK-based trade repository registered with ESMA—Bloomberg’s UK trade repository—withdrew its registration with ESMA. There is currently no equivalence decision for trade repositories in place with any non-EU country.
32 The regulation-making powers under the Financial Services Bill expire two years after the UK’s exit from the EU without a Withdrawal Agreement. It is a possibility that further regulation-making powers in this area are created before that deadline.
33 However, in our view, the Financial Services Bill cannot properly be described as a ‘no deal’ preparation. None of the EU legislation for which the Treasury is seeking implementing powers under the Bill will actually be in force for months, if not years, after the scheduled ‘exit day’ on 12 April 2019. Indeed, many have not even been formally adopted by the European Parliament and Council. The amendments to EMIR under the REFIT Regulation, for example, will not be fully in effect until spring 2021 at the earliest. We accept that the regulation-making powers sought by the Treasury to implement EMIR REFIT and other EU financial services proposals in a ‘no deal’ scenario may make sense from an administrative perspective.
34 A derivative is a financial contract that derives its value from the performance of an underlying asset or entity, such as a currency, interest rate or commodity. They can be used as a hedge, for example against exchange rate fluctuations, or speculatively, for example to bet that a company will default on its debt obligations.
35 BIS, ““ (accessed 19 February 2019).
36 AIG was the subject of a US Government bail-out totalling $180 billion. It had sold a large amount of OTC derivatives called credit default swaps (CDS), which insure the buyer against some other loan (for example a mortgage) defaulting. AIG had not set aside sufficient capital to cover claims against it under the CDS when the other loans started to fail.
39 See Bank of England ‘’.
40 CME Clearing Europe, ICE Clear Europe Limited, LCH. Clearnet Limited and LME Clear Limited. There are 17 CCPs as a whole.
41 See COM(2016) 857: under Article 85(1) of Regulation (EU) No 648/2012 on OTC derivatives, central counterparties and trade repositories.
42 See . Our predecessors considered the Recovery and Resolution Regulation in their Reports of and . Negotiations on this proposal are on-going in the Council and the European Parliament, conducted separately from the EMIR package as it is not concerned with authorisation and supervision of CCPs per se. The proposal remains under scrutiny in anticipation of further information from the Government.
43 Our predecessors considered the report in January 2017. See: (38314) 14828/16: Twenty-fifth Report HC 71–xxiii (2016–17), (11 January 2017). It remains under scrutiny.
44 See .
45 Pension funds are exempted from the clearing obligation because they do not typically hold the necessary cash or liquid assets to fulfil the margin requirements imposed by EMIR. To impose the clearing obligation would necessitate the diversion of their invested funds, ultimately reducing the income they can provide for their customers in retirement.
46 The Commission argues that suspension of the clearing obligation may be necessary, for example if the CCP clearing the biggest portion of a certain OTC derivatives class has exited that market.
47 submitted by HM Treasury (3 July 2017).
48 See paragraph 0.23.
49 The Minister’s letter refers to the mandate as a ‘general approach’. This is not strictly correct, as ‘general approaches’ are adopted by Ministers, not their permanent representatives, and as such are subject to the scrutiny reserve (which applies to formal decisions taken by the Council of the EU). ‘Mandates for negotiations’ adopted by COREPER are not subject to the scrutiny reserve.
50 An SSPE is a corporation trust or other entity established specifically to carry out a securitisation or securitisations, for example of mortgage loans, legally isolating the obligations of the SSPE from those of the originator institution (like a bank). Under EMIR, many SSPEs are exempt from the clearing and margining requirements where they engage in derivatives transactions. The original Commission proposal would reclassify them as “financial counterparties”, meaning they would be fully within the scope of those requirements. The financial services industry had expressed concerns that posting margin would require SSPEs to hold more cash or be restructured, with compliance functions delegated to a third party. The UK Government’s position is that SSPEs, even if categorised as a financial counterparty under EMIR, should nonetheless not be subject to the clearing obligation.
51 Exchange-traded derivatives (ETDs) are not traded over-the-counter, but, as the name implies, via a regulated exchange. The Markets in Financial Instruments Regulation (MiFIR) requires every ETD in the EU to be cleared by a CCP, and to be reported by both counterparties to a Trade Repository. The REFIT proposal by the Commission would introduce single-sided reporting by the CCP for exchange-traded derivatives (ETDs), removing that responsibility from the counterparties themselves. The UK Government believed the Commission proposal would mainly result in burden relief for clearing members, who are least likely to need it given their size and sophisticated compliance machinery. Some Member States were pushing for ETDs to be removed from the scope of EMIR altogether and refer to MIFIR, while others had expressed concern about the lack of legal clarity resulting from the difference between “positions” (under MiFIR) and transactions (under EMIR).
52 The Committee wrote to the previous Economic Secretary on 18 December 2017, asking to “receive a copy of the mandate as soon as it becomes available, accompanied by an explanation of the Government’s position on it”.
53 In the Member States’ proposal, references to the insolvency estate of a failed clearing member itself were removed, so that the amended version of EMIR would focus solely on the assets and positions in client accounts (which, under the new Regulation, could be “ported or liquidated with greater certainty”). A on the recovery and resolution of failing CCPs–to mirror a similar legal framework for banks—remains under scrutiny.
54 Technical regulatory standards would need to be adopted by the European Commission on the basis of ESMA’s draft, and could be vetoed either by the Council or the European Parliament as they take the form of a Delegated Act.
55 In January 2019, ESMA that the delays in the adoption of the legislation meant that smaller financial counterparties and reporting entities in particular were at risk of becoming subject to superfluous legal obligations which the REFIT proposal was designed to eliminate. The Authority effectively notified the Member States’ national financial regulators that they should “apply their risk-based supervisory powers in their day-to-day enforcement of EMIR in a proportionate manner”.
56 The exemption for pension schemes is meant to protect savers’ retirement income from being eroded by the cost of their pension fund having to clear their transactions, as this requires posting of collateral. The two years plus two years construction is a compromise, as France and the European Parliament wanted to limit the exemption while the UK, the Netherlands and Denmark favoured extending it further.
57 See the new .
58 See the new .
Published: 2 April