21 March 2012

ISDA, AFME, BBA published response to first ESMA Discussion Paper on EMIR

Their priority in addressing requirements for CCPs is to ensure that they are both safe and efficient, given the level of risk concentration they imply.

The associations make the following comments on key themes covered the Discussion Paper, and in their response:

"We welcome the recognition of the global nature of the OTC derivatives business in EMIR, as underlined by the EMIR mechanisms to deal with conflicts and under laps between EU and 3rd country regulation of OTC derivatives, as well as the scope permitted for third country CCPs and trade repositories to provide their services to EU market participants. We believe it is important to clarify what the perimeters of EU regulation are before ESMA can tackle mandates addressing contracts with ‘direct, substantial and foreseeable effect’ in the EU that are not covered by EU regulation, or contracts transacted as such with the purpose of evasion of EU regulation. Legal uncertainty about extraterritorial application of such rules to contracts (and hence the potential for legal conflicts) will hamper markets that are the most global in nature. As the mandate to ESMA in Article 3.2a was a late addition to EMIR Level 1 (as acknowledged by ESMA), we ask that ESMA consult with industry as its thinking develops (so that issues pertaining to ‘evasion’ and ‘direct, substantial and foreseeable effect’ are subject to exhaustive consideration). In general, we feel that EU regulators should feel that they can defer regulation to third country regulators where regulation in those countries delivers equivalent regulatory outcomes to those in the EU.

The recognition of the need for indirect clearing in EMIR is welcome, facilitating access to clearing and increasing competition in derivatives clearing business. We raise a number of issues that need further consideration herein in this regard (appropriate segregation options, capital implications, appropriate legal documentation, bankruptcy implications, client choice and tax and accounting considerations, inter alia).

Concerning the clearing obligation, we raise a number of concerns in relation to frontloading herein, in particular pertaining to the need for consideration of the systemic risk implications of mandatory frontloading, competition implications (where CCPs seek to be first to market), and the need for market participants to be made aware as soon as possible of the possibility that frontloading could be required (in order to avoid the operational, legal and funding difficulties ensuing from key terms of the transactions being changed retroactively).

We believe that the notification to ESMA by the competent authority should include a focus on legal and contractual standardisation in the relevant class of derivatives, in order to promote legal certainty in the market. Where a submission by a competent authority regarding eligibility for clearing of a class of derivatives is rejected, we make some suggestions herein to ensure enough rigour regarding risk management capabilities of the CCP is maintained.

We believe that the definition of hedging instruments – for the purpose of determination of measurement versus the clearing threshold of non‐financial counterparties’ participation in derivatives business – should look current beyond hedge accounting rules. We are concerned that the list of types of derivative that can be used for commercial reasons in the Discussion Paper is too restrictive ‐ failing to pay heed, for example, of the valid commercial hedging uses of equity derivatives, inter alia. We further believe that anticipatory hedging, dynamic macro‐hedging and portfolio hedging strategies should be recognised by ESMA. In addition, we believe that it should be clarified that Special Purpose Vehicles (SPVs) should benefit from the exemption from clearing, in recognition of the hedging of debt issuance enabled by SPVs’ use of OTC derivatives.

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