The European Securities and Markets Authority (ESMA) said on Wednesday it is developing a set of technical standards for over-the-counter (OTC) derivatives not cleared by a Central Counterparty (CCP). The unified standards will apply for all EU member states.
The regulator has published a final draft of the Regulatory Technical Standards (RTS). The draft RTS outlines the European Market Infrastructure Regulation’s (EMIR) framework, which aims to enhance the safety of CCPs. The EMIR entered into force in August 2012 and is directly applicable in all EU member states. It requires all OTC derivative contracts to be cleared, while derivative transactions need to be reported to trade repositories.
The unified standards aim to mitigate system risks and increase transparency on the related markets, as well as to ensure consistency within the EU. The draft RTS cover the risk mitigation techniques related to the exchange of collateral to cover exposures arising from non-centrally cleared OTC derivatives. They also specify the criteria concerning intragroup exemptions and the definitions of practical and legal impediments to the prompt transfer of funds between counterparties.
OTC derivatives cleared by CCPs are generally safer since clearing helps mitigate risks. Once adopted, the RTS will be gradually rolled out to ensure counterparties have enough time to apply the requirements.
The draft RTS examines issues related to derivatives margins, eligible collaterals, and timing of the collateral exchange, among others. Following is a list of provisions that it covers:
- For OTC derivatives not cleared by a CCP, the draft RTS prescribe that counterparties have to exchange both initial and variation margins. This will reduce counterparty credit risk, mitigate any potential systemic risk and ensure alignment with international standards.
- The draft RTS outline the list of eligible collateral for the exchange of margins, the criteria to ensure the collateral is sufficiently diversified and not subject to wrong-way risk, as well as the methods to determine appropriate collateral haircuts.
- The draft RTS lay down the operational procedures related to documentation, legal assessments of the enforceability of the agreements and the timing of the collateral exchange.
- The draft RTS cover the procedures for counterparties and competent authorities related to the treatment of intragroup derivative contracts.
The ESMA said it based the draft RTS on the framework established by the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) and the BCBS supervisory guidance for managing risks associated with the settlement of foreign exchange transactions.
The ESMA is an independent EU authority that directly supervises and safeguards the EU financial markets. It has established a single rulebook for EU financial markets and promotes the convergence of the regulatory bodies of EU countries. In addition, it also assesses risks to investors, markets and financial stability.
In the EU, a financial service license issued by any member state applies to the markets of all other EU countries. However, in case of misconduct entities are supervised and penalized by the authorities under which regulation they fall. EU forex brokers predominately choose to be regulated in Cyprus or the UK.