As Europes regulatory framework for over-the-counter (OTC) derivatives takes shape, indirect clearing is firming up as a key and European-centric debate.
The European Securities and Market Authority (ESMA) last week released its consultation paper on draft technical standards under the European Market Infrastructure Regulation (EMIR).
The paper is in line with the ESMAs prior steps towards implementing EMIR, including its February 16 discussion paper. But it means there are still many unanswered questions as to how clearing will work, especially when non-clearinghouse members are involved.
One of the key areas which I think will be incredibly difficult from a legal perspective is indirect clearing, said Harry Eddis, a Linklaters partner in London.
EMIR and the technical standards require portability and collateral protection be provided to underlying counterparties. But there are no rules requiring segregation of client money, as there is in the US.
EMIR does not provide the same statutory protection to collateral as US regulations do and so EU-based CCPs are having to develop their own collateral protection mechanisms, said Eddis, which means this could lead to a multitude of different models.
EMIR was a bit of a missed opportunity in that regard, he added.
Lack of statutory protections puts clearing members in a difficult situation. They must provide collateral for indirect members, sometimes without a direct contractual relationship.
Goldman Sachs raised the issue in its response to ESMAs February 16 discussion paper, suggesting the Authority set out criteria for indirect clearing arrangements.
Trans-Atlantic holding pattern
The consultation paper coincides with the US Commodity Futures Trading Commissions (CFTC) long-awaited provision of cross-border swaps guidance.
ESMAs release last week gives little further guidance on the international reach of Emir. However Richard Heffner, a counsel with Dechert in London said European financial services regulations have tended historically to be less extra-territorial than US regulations.
With 27 member states, the EUs complicated rule-writing process means it lags behind the US in OTC derivative reforms. It seems the interaction of the two regimes has been left in a holding pattern, including through the CFTCs grandfathering allowances, until the EU framework becomes clearer.
There are positive signs though. Compared to its draft of 18 months ago, the final text of EMIR gives greater recognition of swap clearing activity overseas. It certainly seems the US and EU regulators are trying to mesh their regulations a much as possible, Eddis said.
On July 12 ESMA will hold a public hearing on the technical standards. The comment period closes on August 5.