Which derivatives are subject to mandatory clearing?
On 1 March 2016, the European Commission made a second mandatory clearing determination under EMIR. The relevant delegated regulation was published in the Official Journal on 19 April 2016. Credit default swaps (“CDS”) linked to iTraxx Europe Main and iTRaxx Europe Crossover (5 years Euro denominated) will be subject to mandatory clearing.
The first mandatory clearing determination introduced the clearing obligation to certain interest rate swaps, which will be phased in from 21 June 2016.
When does the clearing obligation take effect for these CDS?
The obligation to clear these CDS will take effect as follows:
1. Category 1 (clearing members for at least one of the classes of OTC CDS subject to clearing): 9 February 2017.
2. Category 2 (financial counterparties (“FCs”) and alternative investment funds (“AIFs”) that exceed a threshold of Euro 8 billion aggregate month-end average outstanding gross notional amount of all non-centrally cleared derivatives (the “Threshold” )): 9 August 2017.
3. Category 3 (FCs and AIFs that are not clearing members and that do not exceed the Threshold): 9 February 2018.
4. Category 4 (non-financial counterparties whose rolling average position over a 30 working day period in OTC derivatives (net of their commercial and treasury financing hedges) exceeds a relevant clearing threshold (known as an NFC+)): 9 May 2019.
Please see our earlier Technical Update for further details on counterparty classification.
Where a CDS is entered into between two counterparties in different categories, the date from which the clearing obligation takes effect for that contract will be the later of the two dates applicable to the counterparties.
There is a temporary three year reprieve for intra-group derivative transactions between an EU FC and a third country entity which would be an FC if established in the EU, without the need for an equivalence decision by the Commission in respect of the third country (provided that all the other conditions of the intra-group exemption are met). This three year reprieve may be cut short if the Commission subsequently makes an equivalence decision for the third country prior to the end of the three year period.
Consequences of failing to clear
Member States can apply their own rules on penalties for a counterparty breaching the rules in EMIR. The UK Financial Conduct Authority has the power to impose unlimited fines and to issue a public warning.
Are you prepared for clearing?
Steps to consider:
- Review your existing portfolio to identify potentially in scope derivatives.
- Are you an FC or an NFC+ and is the counterparty to your trade an FC or an NFC+?
- Is the intra-group exemption is available?
- If no exemption is available, then consider whether you wish to become a clearing member. If not, you will need to become a client of a clearing member or enter into indirect clearing arrangements with a broker.
- What amendments have been made to your existing documentation to meet the new requirements?
- What segregation model does the clearing house offer?
- What initial and variation margin requirements are imposed on clearing members by the clearing house?
- What is your exposure to the clearing house default fund?
- What exposure do you have if the clearing house goes bust?
- Do you have access to the right amount and quality of collateral to support your derivative trades?
- Are your systems ready to clear?
If you require assistance, please do not do not hesitate to contact us.
Where the counterparty is an AIF or a UCITS, the Threshold calculation should only apply at the Fund level.