UK research on EMIR shows there is case for exempting smaller FCs from clearing obligations

Maria Nikolova

Analysis of a UK data sample indicates that there is a case for exempting smaller FCs from clearing without compromising the objectives of EMIR.

A research note quoted by the UK Financial Conduct Authority (FCA) provides insight into the objectives of EMIR and their potential consequences for the OTC derivatives market. The research, entitled “EMIR data and derivatives market policies. How EMIR data help regulators better understand the impact of policies” has Anne-Laure Condat, Alessandro Puce and Carsten Nommels listed as its authors.

The analysis is based on a sample of UK financial reporting counterparties’ outstanding OTC derivative trades on 10 April 2018 as reported under EMIR. Based on a sample of UK derivatives data, the research has found that a clearing exemption calibrated to minimise the number of counterparties that will be subject to the clearing obligation while maximising the amount of activity that is captured could significantly reduce burdens on those counterparties without hampering the achievement of EMIR’s overall objectives.

In 2012, the European Union (EU) adopted EMIR. EMIR introduced new requirements on market participants with the aim of improving transparency and reducing counterparty credit risk and operational risk in the derivatives market. On top of new reporting obligations, EMIR also introduced mandatory central clearing requirements for standardised over-the-counter (OTC) derivative contracts.

Under EMIR, all financial counterparties are subject to the clearing obligation, regardless of the size of their derivatives activity. The clearing obligation also applies to certain non- financial counterparties (NFCs), but only if their derivatives activity is above any of the asset class specific clearing thresholds.

To secure a gradual and orderly implementation of the clearing obligation, EMIR splits financial firms into three categories. These are based on the size of their derivatives activity and whether they are already a clearing member of a Central Counterparty (CCP). The clearing obligation applies in phases to the first, then the second and finally the third category of financial firms. Non-financial firms are in a fourth category. To date, only the first two categories of financials firms are subject to the clearing obligation.

Based on the data sample, the research concludes that the UK OTC derivatives market remains characterised by a high level of concentration, with a small number of large financial counterparties accounting for the vast majority of market activity. Conversely, a relatively modest contribution is made to overall activity by a large number of smaller financial counterparties.

Against this background, in May 2017 the Commission published a proposal for a targeted review of EMIR to simplify the rules and make them more proportionate, without compromising the objectives of the legislation.

Inter alia, this proposal introduces an exemption from clearing for small financial counterparties (FCs), where ‘small’ means that a financial counterparty’s derivatives activity is below each of the asset class specific clearing thresholds currently applicable to non-financials under EMIR. The relevant thresholds are € 1bn in gross notional for credit and equity derivatives, and € 3bn for interest rate, Forex and commodity derivatives. And, vice versa, if a financial counterparty were to be above any one of the asset class specific thresholds, it would not benefit from the exemption and all its derivatives would have to be cleared.

Using the data sample, the researchers looked at how the number of FCs subject to the clearing obligation would vary in the context of the Commission’s proposal.

Based on the UK data sample, the Commission’s proposal would result in:

  • 13.8% of FCs active in the interest rate asset class being subject to the clearing obligation, and just above 99.8% of the aggregate interest rate activity entered into by FCs active in the interest rate asset class being potentially subject to clearing if all interest rate derivatives were subject to the clearing obligation;
  • 17% of FCs active in the credit asset class being subject to the clearing obligation, and 99.3% of the aggregate credit activity entered into by FCs active in the credit asset class being potentially subject to clearing if all credit derivatives were subject to the clearing obligation.

The analysis of the UK data sample clearly shows that there is a case for exempting smaller FCs from clearing without compromising the objectives of EMIR, as the Commission has proposed.

However, only analysis of the entire EU-level dataset would enable a comprehensive understanding of the impact of the proposed thresholds on the number of FCs that would be subject to clearing and the corresponding market activity that would be subject to the clearing mandate.

Read this next

Digital Assets

FINMA-regulated digital asset provider Taurus expands into Germany

This expansion follows recent moves by BaFin to accelerate the licensing of crypto custody services, aiming to boost market confidence. Following this, several new licenses were issued, notably to Commerzbank, making it the first full-service financial institution in Germany to receive a crypto custody license.

Inside View

Stocknet’s Nick Hall defends gamification as trading platform market set to hit $15.34b by 2030

“The growing popularity of gamified trading has the potential to tackle this financial literacy gap. Rather than simply giving users unfettered access to markets and letting them figure things out for themselves, platforms can offer virtual skill games and challenges to help educate traders and prime them for success.”

Inside View

Infographic: Interest rate and FX derivatives are driving rise of OTC derivatives market

These trends suggest a growing and evolving OTC derivatives market, with an increased focus on risk management and regulatory compliance. The rise in clearing rates, along with the increased initial margin requirements, reflects a more cautious approach to risk in the financial services industry.

Market News

Bank of Canada’s Final 2023 Policy Update on the Canadian Dollar and Future Monetary Landscape

The Bank of Canada’s final policy update for 2023, as reported by Bloomberg, had a relatively subdued impact on the performance of the Canadian dollar, especially when compared to the discernible market reactions following prior BoC policy decisions throughout the year.

Inside View

DTCC’s Systemic Risk Barometer Survey found 2024 US Presidential Election as a top risk

U.S. political uncertainty, particularly regarding the 2024 Presidential Election, has emerged as a key risk, with 51% of respondents highlighting it as a major concern. This reflects the potential impact of election outcomes on market conditions and the industry.

Executive Moves

Options Technology promotes Laura McCann to CFO

“Laura’s promotion to CFO is the next stage in our long-term strategy of building a world-class finance team servicing the global business from our Belfast office. Back in 2016, Jon took on the challenge of laying the groundwork for that vision. Laura has been an integral part of the strategy from day one.”

Digital Assets

Thailand’s crypto economy under the spotlight: a report by HashKey Capital

“I’m excited by the rapid expansion of Thailand’s Web3 sector. With over 3 million overall crypto users and 600% growth in the market in recent years, the dynamism in our DeFi and NFT sectors is clearly evident. Thailand is increasingly becoming a hotspot for digital nomads, drawn by our crypto-friendly policies, affordable living costs, vibrant food and beverage culture and diverse cultural landscape.”

Retail FX

Webull Australia offers 5.4% yield on uninvested cash

“US dollar money market funds are heavily regulated, meaning client funds are managed in a safe, reliable and trusted environment, which is of critical importance to us, and continues to remain top-of-mind for our clients.”

Digital Assets

Bybit welcomes Ethena’s USDe, a decentralized stablecoin utilizing delta-hedging staked Ether

“Our collaboration with Ethena Labs represents our commitment to solving some of the biggest challenges in crypto today, not least, the creation of a decentralized stablecoin. The integration of USDe on Bybit expands our stablecoin offerings, providing our users with an array of uncorrelated solutions accessible from our Unified Trading Account.”