July 17, 2014 3:46 pm

Respite for derivatives deals from incoming European rules

Swaps dealers and banks are set to win a respite from meeting incoming European derivatives rules after regulators admitted their implementation put market participants’ right to legal certainty of their contracts at risk.

The European Commission has agreed with a proposal suspending the status of derivatives deals entered into from March 18 until the region’s main regulator determines which instruments should face mandatory clearing later this year.

In a letter to the European Securities and Markets Authority (Esma) last week, Michel Barnier, the EU commissioner in charge of financial services, acknowledged the implementation process “could jeopardise the principle of legal certainty” for market participants.

A formal agreement may signal an end to months of confusion among swap dealers and their lawyers over so-called “front-loading” of their trades, in which outstanding swaps may have to be processed through clearing houses at a later date if regulators include that product in their final rulings.

However, uncleared trades are likely to face higher collateral and capital charges. Market participants have complained that the uncertainty of the future status of the swap means they cannot price it accurately.

The Commission’s indication to Esma means market participants are likely to be given several months’ preparation and a definitive date to work from.

“It’s great that this has brought clarity and removed the uncertainties that were bedevilling the market”, said John Wilson, former head of OTC Clearing at Newedge, the derivatives broker.

The ruling would only become legal when the commission formally ratifies Esma’s technical standards. The Paris-based regulator may only make its first decisions on the types of interest rate swaps, credit and foreign exchange derivatives to face mandatory clearing in November. Consequently the formal guidelines are likely to come into force between November and June 2015.

“The Commission considers that before Esma submits the technical standards to the commission, counterparties cannot reasonably foresee the terms of the front-loading obligation,” Mr Barnier wrote to Steven Maijoor, chairman of Esma.

Esma had warned the uncertainty could lead to market participants choosing not to hedge their risks.

Mr Barnier said the European rules were not intended to undermine “the overarching objective of the clearing obligation to reduce systemic risk. The Commission is of the view that the front-loading of OTC derivatives should be avoided in cases where it would not ensure the achievement of those objectives.”

It was triggered on March 18 after Nasdaq OMX was the first European clearing house authorised under the new rules to clear certain OTC derivatives products.

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