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by Roland Kielman

European financial reform came into sharper focus recently with publication of the European Securities and Markets Authority’s (ESMA) final report outlining draft technical standards for over-the-counter (OTC) derivatives, central counterparties (CCPs) and trade repositories. The report’s completion is viewed as one of the critical steps in the implementation of the European Market Infrastructure Regulation (EMIR) – Europe’s primary response to the global commitment to overhaul the vast and previously opaque OTC derivatives market.

“This is a significant achievement for ESMA and the European Union,” said Diana Chan, CEO of EuroCCP, DTCC’s European clearing subsidiary. “While there is still work to be done, ESMA has moved Europe one step closer to a supervisory framework that will enhance the resiliency of central counterparties and the manner in which the industry manages and reduces risk in the OTC marketplace.”

Devil in the details
The EMIR package was originally adopted by the European authorities on August 16, 2012, after publication in the Official Journal of the European Union. By this time, ESMA had already begun the process of drafting the regulatory and technical standards stipulated in EMIR, with the final version of the report due by September 30, 2012.

After extensive consultation with industry stakeholders, ESMA published its final report with three days to spare on September 27. The European Commission has now begun to review the document – a process that may still result in changes to the standards over the course of the next three months.

The original regulation outlined, among other things, requirements for the centralized clearing of OTC derivatives, a framework for transaction reporting and the registration of trade repositories, risk mitigation standards for non-cleared OTC derivative instruments, including capital requirements, as well as obligations for non-financial firms.

It ultimately fell to ESMA, however, to work out the details of many of these proposals in the form of regulatory and technical standards, which are critical for market participants to clearly define and therefore discharge their regulatory obligations under EMIR.

Over the course of its work, ESMA solicited feedback from stakeholders in the form of two consultation papers during the summer of 2012.

“EMIR provided the skeleton of the future regulation, but it was up to ESMA and the industry to work together to put flesh on the bones,” said Andrew Douglas, DTCC Head of Government Relations in Europe.

“Given the extraordinary time and resource constraints, stakeholder cooperation was critical.”

Diana Chan, CEO, EuroCCP

‘While there is still work to be done, ESMA has moved Europe one step closer to a supervisory framework that will enhance the resiliency of central counterparties and the manner in which the industry manages and reduces risk in the OTC marketplace.’ – Diana Chan, CEO, EuroCCP

Skin in the game
DTCC actively participated in the development of EMIR and the ESMA technical standards, focusing specifically on CCPs and trade repositories – two of the company’s primary service offerings in the E.U.

“The process gave us the opportunity to leverage our unique expertise related to CCPs, trade repositories and legal entity identifiers to assist ESMA in fine-tuning the EMIR proposal,” said Stewart Macbeth, President and CEO of DTCC’s Deriv/SERV LLC subsidiary.

DTCC, through EuroCCP, submitted extensive feedback to ESMA’s draft technical standards, including comments on organizational and business conduct, margin requirements, CCP default fund, liquidity risk management, and stress-and back-testing requirements. EuroCCP has been a strong advocate for interoperability among cash equity CCPs, as well.

DTCC also weighed in on a number of proposed requirements for trade repositories, including the format and level of granularity of data to be reported to and by a trade repository, the use of legal entity identifiers and the reporting of mark-to-market valuations and collateral.

E.U./U.S. harmonization
The ESMA standards reflect similarities with the U.S. Dodd-Frank regime, such as the phasing-in of OTC derivatives transaction reporting based on asset class. The reporting of credit and interest rates is expected to be required as of July 2013, with requirements for foreign exchange, commodity and equity derivatives expected to take effect in January 2014.

Unique to EMIR, however, is a recommendation for the reporting of information related to collateral on a portfolio basis, although this will most likely not be required until sometime in 2014.

Given the ongoing debate surrounding the extraterritorial impact of new OTC derivatives rules, particularly those tied to the Commodity Futures Trading Commission (CFTC)’s Title VII regime, ESMA refrained from addressing third-country issues in its report. It is anticipated that the regulator will address these issues in forthcoming standards, expected after the CFTC provides additional clarity to its proposed approach.

On the horizon
With less than three months until the deadline for G20 derivatives reform, the European Commission, with input from the Parliament and Council of the European Union, will continue to review the ESMA standards before approval, anticipated by year-end. Full implementation of EMIR is expected to take more than a year once final approval is obtained.

In the meantime, European policymakers continue to forge ahead with the review of the region’s Markets in Financial Instruments Directive and Regulation and other financial policy initiatives, such as the Central Securities Depository Regulation and Market Abuse Directive, among others.@