Where Next for Eurozone Clearing?

Europe’s Grand Design

In November 2021, the European Commission (“EC”) announced the EU’s proposed way forward for central clearing in the post-Brexit world.

The EC considers the over-reliance on UK-based central counter-parties (“CCPs”) for some clearing activities as a source of financial stability risk in the medium term, which requires mitigation.

Specifically, the EC has identified the following UK CCPs as of “systemic importance” and classified them as “Tier 2 CCPs” under the current framework:

  • Swapclear by LCH Ltd, for both Euro and Polish Zloty-denominated products
  • The STIR futures by ICE Clear EU for euro-denominated products
  • The CDS Service by ICE Clear EU for euro-denominated products

The EC’s preferred approach is to reduce their exposures to these Tier 2 CCPs and to make EU-based CCPs more attractive to market participants through measures classified under these two pillars:

  1. Build its own domestic capacity to clear euro-denominated derivatives
  2. Supervise these clearing activities directly without equivalence

These two pillars are considered foundational in achieving EU’s twin objectives to a) mitigate potential risks to EU financial stability and b) build the capital markets union (“CMU”).

EC Consultation on EU CCP framework

On 8 February 2021, the EC launched its online survey (“EUSurvey”) to market participants on a wide range of topics that will support the formulation and development of measures falling under the two pillars.

These themes from the EUSurvey give us some flavour of what may be coming our way:

  1. Broadening the scope of clearing participants
  2. Broadening the scope of products cleared
  3. Higher capital requirements in CRR10 for exposures to Tier 2 CCPs
  4. Exposure reduction targets toward specific Tier 2 CCPs
  5. Macroprudential tools
  6. Obligation to clear in the EU
  7. Active account with an EU CCP
  8. Hedge accounting rules
  9. Use of post-trade risk reduction services
  10. Fair, reasonable, non-discriminatory and transparent (FRANDT) commercial terms for clearing services)
  11. Measures to expand the services by EU CCPs
  12. Payment and settlement arrangements for central clearing
  13. Segregated default funds
  14. Enhancing funding and liquidity management conditions
  15. Interoperability

The EUSurvey ended on 22 March 2022. The EC plans to further publish on the survey findings and measures in the second half of 2022.

The Extension of the Temporary Equivalence for UK-based CCPs

At the same time, the EC extended the equivalence for UK-based CCPs until 30 June 2025. The current equivalence was due to expire in June 2022.

Effectively, the EC has given itself three years to achieve its post-trade ambitions

Potential Extension of Clearing by Pension Scheme Arrangements

As part of its grand design, the EC recognises the ability for Pension Scheme Arrangements (“PSAs”) to mandatory-clear, being a key milestone on its post-trade roadmap. In its letter to the EC on 25 January, 2022 ESMA recommended a final extension of the clearing-mandate exemption applying to PSAs until 19 June 2023.

Although ESMA recognises a very high level of operational readiness of PSAs to clear their OTC interest rate derivatives, strong concerns from PSAs remain with regards to their liquidity-preparedness to meet potentially large variation margin cash calls under stressed market situations, given their generally large and directional positions. Since ESMA first reported on this subject in April 2020, viable solutions to resolve the liquidity risk are still being sought. This is evident in the current EU survey, where a top section is devoted to PSAs clearing.

The current PSA exemption runs until 18 June 2022. While the EC has yet to finalise its decision, we are aware of clearing brokers working with CCPs to offer better liquidity for PSAs to centrally clear. In addition, the last phase of Uncleared Margin Rules is encouraging phase six buy-side firms to assess whether they are optimised in utilising central clearing and amending strategy where they are not.

Are you ready?

At Margin Reform we have a team of expert practitioners experienced in margin reduction, capital conservation, and collateral optimisation across both cleared and bilateral markets.

We work closely with market-leading clearing houses, top-tier sell-side institutions, and critical market infrastructures, where we partner to provide a wide range of post-trade solutions. We are ready to support firms navigating the clearing universe.

Why not call us now to make sure you’re ready? +44 (0) 20 3662 8805 | info@marginreform.com | www.marginreform.com

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