by Judy Inosanto
The European Commission released in September its much-anticipated legislative proposal for financial reform, European Market Infrastructure Regulation or EMIR. (The formal name is Regulation of the European Parliament and of the Council on OTC derivatives, central counterparties and trade repositories.) Intended to promote transparency and safety in the European financial system, EMIR addresses a number of key issues for lawmakers and regulators, including greater standardization and oversight of the over-the-counter (OTC) derivatives market, as well as interoperability, governance and the ownership structure of central counterparty (CCP) organizations.
The draft text is seen to be consistent with provisions in the U.S.’s recently enacted Dodd-Frank legislation (see article, page 1). EMIR also is in line with the G-20 commitments to mitigate risk in the trading of OTC derivatives instruments.
“DTCC believes that risk mitigation and market transparency are vital to protecting the integrity of the global marketplace,” said Larry Thompson, DTCC managing director and general counsel. “The work done by global regulators and lawmakers so far is a significant step toward achieving those goals.”
For EMIR to be enacted into law, the Commission’s proposal must be approved by both the European Parliament and the Council of Ministers representing each of the 27 European Union (EU) member states. It is anticipated that the legislation will come into effect by the end of 2011.
EMIR’s provisions for OTC derivatives cover both central clearing and the use of repositories. “OTC derivatives have a big impact on the real economy: from mortgages to food prices. The absence of any regulatory framework for OTC derivatives contributed to the financial crisis and the tremendous consequences we are all suffering,” said Michel Barnier, the European Commission’s commissioner for Internal Market and Services.
“Today, we are proposing rules that will bring more transparency and responsibility to derivatives markets. So we know who is doing what, and who owes what to whom.” As part of efforts to minimize counterparty risk, EMIR would mandate that standardized OTC derivatives transactions be cleared through central counterparties (CCPs). The objective of this provision is to ensure that in the event of a failure of a market participant, that participant’s outstanding positions would be made whole, thus avoiding the subsequent collapse of one or more of its counterparties, which could put the entire financial system at risk.
The European Securities and Markets Authority (ESMA), the new pan-European regulatory body expected to be put in place in January 2011, will have responsibility for determining which contracts are potentially subject to clearing. While supervisory authority of the CCP will fall under the jurisdiction of the CCP’s domicile, ESMA will play an important role in the authorization process, given the systemic importance of these entities and cross-border nature of the marketplace.
To increase market transparency, EMIR also calls for all OTC derivatives trades in the E.U. both cleared and noncleared, to be reported into a trade repository. Surveillance of repositories would fall under ESMA.
The legislation gives regulators in the E.U. access to these repositories as a means for allowing supervisory authorities to more effectively assess risk in the market. Trade repositories will also be required to publish aggregate positions for each OTC derivatives class as a way to enhance transparency in the marketplace.
“DTCC is committed to bringing greater transparency to the OTC derivatives market and facilitating the identification of systemic risk buildups,” said Thompson. “It is our bedrock principle that regulators, no matter where they are located, must have unfettered access to our trade repositories for the data they need to fulfill their regulatory obligations. We believe the Commission’s provisions on trade reporting recognize the value that trade repositories deliver in helping regulators and the public gain a better understanding on the size and scope of this global market.” (See box at right for a description of DTCC’s repositories.)
The legislation also encourages interoperability among CCPs operating in cash equity instruments. DTCC and its pan-European clearing subsidiary, EuroCCP, strongly advocate this principle. The proposal emphasizes that regulatory approval is a pre-requisite for any interoperability arrangement.
Rather than explicitly impose ownership restrictions, EMIR calls for a robust governance structure for CCPs, requiring that at least one-third of board members be independent directors. This provision addresses potential conflicts of interest between owners, management, clearing members and independent participants.
In addition, no risk management structures will be allowed to be outsourced and CCPs are expected to have strict prudential requirements. @