ESMA’s proposed technical standards for OTC derivatives et al

August 6, 2012

ESMA has been consulting since June on ‘draft technical standards’ on regulation of OTC derivatives, CCPs and trade repositories. Dry it may sound but this is of course the crucial ‘rule-making’ stage of the implementation of EMIR, the European Union’s regulation addressing OTC derivatives in the post-crisis (2008 version) aftermath.

The position we have taken in the EACT is well documented and the exemption won for non-financial end users has provided a breathing space for the use of derivatives in corporate risk management, even if this may not be the long-term solution in the commitment to reduce global financial systemic risk (see blog “Financial regulation: winning the battle and the war; but what about the future?”, 16 July 2012).

ESMA’s consultation has raised more issues than I suspected it would. Our response can be downloaded here and it might be helpful to summarise the key issues:

➢ The corporate exemption is based around contracts that are ‘objectively measurable as reducing risks’ and includes the words ‘in the ordinary course of….business’. We would like to see these latter words deleted if at all possible. We are also arguing against the explicit exclusion of hedging contracts associated with stock option plans

➢ Clearing thresholds are central to the operation of the end-user exemption and we identify issues in ESMA’s drafting around the treatment of intra-group transactions and (more fundamentally) the absence of clear alignment between actual and developing proposals in the US and from BCBS/IOSCO (who have a global remit)

➢ The administration requirements defined by ESMA, in the context of what the organisation refers to as ‘risk mitigation techniques’, are seen by us as posing excessive burdens on all non-financial end users but especially on SMEs

➢ Finally (and most crucially) there appears to be a requirement emerging in ESMA’s detailed proposals for all market participants to report daily mark-to-market values to a trade repository. As we say in our response to ESMA, we can see no possible regulatory justification for this and can identify serious administrative implications for large as well as small companies

My overall feeling after drafting our ESMA response? It is that despite all our efforts over EMIR there is still a huge challenge in persuading European authorities that non-financial end users are totally different from the financial sector participants with whom regulators are much more familiar.

So we see a continuing inability on the part of the EU bodies to recognise two things in particular: that the non-financial companies we are discussing do not and have not in the past directly driven financial sector systemic risk; and that the resources, especially IT systems, available to these companies are simply not on a sufficient scale to handle regulatory requirements drafted from the perspective of the financial sector.

The consequences of the first point above are reflected in issues such as the perverse view being taken of hedging of company stock options and the requirement for daily mark-to-market reporting. The second point is reflected in the unreasonable administrative burden being imposed in respect of information that will do nothing to help regulators reduce systemic risk and support the stability of the financial system – which is what they should be doing.

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