10 Key Regulatory Focus Areas for UK/European Wholesale Markets in 2019

By David Berman, Carl Fernandes  Nicola Higgs, Rob Moulton, Charlotte Collins, and Christopher Sullivan.

In the fifth post of this 10-blog series, we identify key milestones in the derivatives market for the year ahead. This is taken from our wider publication: 10 Key Regulatory Focus Areas for UK/European Wholesale Markets in 2019 – Progress Report. Read the full publication here.

Margin and clearing requirements

Phasing in under EMIR of the initial margin (IM) and clearing obligations continues during 2019. On 21 June 2019, category 3 counterparties became subject to the clearing obligation. However, EMIR Refit provides a four-month period to establish clearing arrangements from the date on which in-scope entities notify ESMA of their clearing threshold calculations. As a result, category 3 counterparties subject to mandatory clearing for interest rate and credit derivative products on 21 June 2019 have until 17 October 2019 to implement their clearing arrangements.

On 9 August 2019, the clearing obligation will apply to all category 4 counterparties in respect of interest rate derivatives denominated in certain EEA currencies. The BCBS and IOSCO announced on 23 July 2019 that they are recommending extending the final phase-in of IM requirements by one year. Implementation would be split, such that entities with an aggregate average notional amount (AANA) of non-centrally cleared derivatives between €50 billion and €750 billion would still have to comply with the 1 September 2020 deadline, but entities with AANA between €8 billion and €50 billion would not have to comply until 1 September 2021. It should be noted that the recommendation is not binding, and would require amendments to EMIR in order to take effect. While it seems likely that the EU will follow the recommendation, market participants must wait for the EU to confirm its intentions.

EMIR Refit

On 17 June 2019, the EMIR Refit amendments entered into force. Highlights include:

  • AIFs established in the EU fall within an expanded definition of FC, even if the AIF manager is non-EU (subject to limited exceptions). This means that margining and (should the funds breach the clearing threshold) clearing will apply. Non-EU AIFs became subject to the same margining and clearing requirements when trading with EU banks.
  • NFCs above the clearing thresholds only need to clear the relevant asset class for the threshold exceeded. However, once an NFC breaches a clearing threshold for any asset class, the NFC must still margin all asset classes.
  • The concept of “small financial counterparties” (SFCs) was introduced for small FCs that fall below the same clearing thresholds that apply to NFCs. This means that SFCs are no longer required to clear. However, unlike NFCs, SFCs still need to margin and once they breach a clearing threshold for any asset class they must clear all asset classes.
  • FCs will be required to report (from 18 June 2020) on behalf of NFC counterparties, and NFCs will be under a corresponding requirement to provide necessary related information to the reporting FCs.

CCP location

The EU legislators are now close to finalising further amendments to EMIR that will introduce the controversial CCP location policy. The proposed amendments, known as EMIR 2.2, will empower the European Commission to determine that some third-country CCPs are of such systemic importance that they can provide services in the EU only if they are located in the EU. On 18 April 2019 the European Parliament adopted the proposed amendments. The next step is endorsement by the Council (expected in Q3 2019), following which the EMIR 2.2 amendments will be published in the Official Journal of the EU and enter into force 20 days later.

MiFID II derivatives trading obligation

MiFIR imposes an obligation on a wide range of counterparties to trade certain derivative contracts on trading venues, rather than OTC. ESMA’s public register states that category 3 counterparties are subject to the derivatives trading obligation (DTO) as of 21 June 2019. However, EMIR Refit raises uncertainty among market participants as to whether the DTO applies to SFCs and NFCs not subject to the clearing obligation (there is no carve-out from the DTO, but the legislation links the clearing obligation and DTO). ESMA issued a statement in July 2019 advising that, although this issue cannot be resolved properly until the legislation is amended, national regulators should exercise forbearance in this area (i.e., they should not take enforcement action against firms that are not subject to the clearing obligation for non-compliance with the DTO). ESMA also clarifies that category 3 counterparties are not subject to the DTO until four months following their notification to ESMA and the relevant national regulators.