The vote in ECON, in effect rejecting ESMA’s rule drafting for EMIR, is still puzzling many of us. We began with a scratching of heads – from where had come this rather belated push by ECON to protect the interests of the real economy in derivatives regulation?

One cynical answer that has been volunteered to me is that it was primarily a result of aggressive lobbying by ISDA and AFME – the usual suspects, some would add, and not the sort of company that the real economy naturally welcomes or feels comfortable with. And in the next breath the energy companies are mentioned.

That the energy companies have been lobbying hard should not surprise us. These are the companies most affected by the single most egregious piece of drafting by ESMA, which removes the exemption from clearing once a single asset class threshold has been breached. The politicians and lawyers can be left to decide whether in doing so ESMA exceeded its mandate in the Level I legislation. But the asset class breach rule is the one area with which we should be really concerned and grateful to ECON for their resolution.

The next puzzle is over where we go next. There are two stages here. Firstly, we need to see whether Parliament votes through the resolution; we will have the answer on this by tomorrow afternoon. The second stage – assuming that there is sufficient support for the resolution – is described to me by old Brussels hands as ‘uncharted territory’. So no easy signposts there.

The stance of the EACT is becoming clearer:
– we think that ECON has raised real concerns, especially so with the asset class breach rule
– but we have no interest in seeing the whole fabric of ESMA’s rules being put back into the melting pot
– implementation delay, whilst bad for global regulatory progress, may be seen as less bad given the lack of proper preparation for implementation

If we can help Brussels unscramble its somewhat unfortunate mess we would be happy to do so! But first of all let’s see what happens in Parliament tomorrow.


I blogged previously on the challenge from ECON in the European Parliament to the detailed rules drafted by ESMA for the implementation of EMIR. Since then a huge number of emails and draft documents have flown around; it’s a real struggle to keep track of who is trying to achieve what – quite apart from speculating as to what might be the outcome.

Maybe it’s time for some home truths. As an amateur observer of the Brussels scene but one with a commitment to fight the corner for the ‘real economy’ in highlighting short-sighted financial regulatory proposals, I note the following:

1 – There is a significant element of ‘politics’ in this, even if the motivation is I believe largely non-partisan. I’m told that members of ECON are determined to flex their muscles vis-à-vis ESMA and therefore the Commission.

2 – However the MEPs have done their homework and should be credited with this. They argue through the amendments that ESMA has gone beyond its authority from the Level 1 content of EMIR. The chair of ESMA, Steven Maijoor, vigorously denies this in a letter he wrote on 28 January to the chair of ECON, Sharon Bowles – insisting that the drafting for which he is responsible is ‘in line with the Level 1 text’.

3 – Maijoor’s letter (equally vigorously) insists that there is a coherence and balance within the ESMA rules as they impact non-financial counterparties; so his challenge back to the MEPs seems to be that if you reject one rule (such as the use of gross rather than net positions) you are putting back into play all the other rules – the equilibrium will have been upset.

From the standpoint of non-financial counterparties does this spat between European institutions – if that is what it really is – matter greatly?

I would argue that the answer may be largely no – it matters not greatly.

There is one exception to this and that is with the rule on asset class breaches. We and others argued from the outset that it would unhelpful to have the clearing obligation triggered across all asset classes in the event of a single class breach. ESMA disregarded this and wrote the rules in such a way that one breach puts all the entity’s transactions into clearing. The ECON amendments include the challenge that this is in breach of Level 1. Maijoor’s letter to Bowles rejects the challenge, insisting that the approach is consistent with Article 10(3) of EMIR.

The less than veiled threat within Maijoor’s letter is that non-financial counterparties will be worse off (through more restrictive rules) if the coherence and balance of what ESMA has drafted is upset through Parliament’s rejection of the detail.

This should be of concern. But it has to be said that for the great majority of non-financial counterparties such a change would be largely irrelevant. The good news is that ESMA’s drafting – and the content of EMIR – allows for sensible recognition of legitimate hedging (risk mitigation) by corporates and excludes such transactions from the clearing obligation. So long as that fundamental approach remains intact, which it surely must do, non-financial counterparties should be relatively relaxed.

The exception to this relatively relaxed view of the current shenanigans between ECON and ESMA is of course the group of corporates with a combination of conventional treasury risk mitigation and of trading activities (the energy companies, most obviously). For them the asset class breach rules become much more relevant and for that reason if for no other I continue to believe that this is the single ‘hot’ issue in the current debate.

A Reuters story today by Huw Jones is fascinating as much for what it does not say as for what it does. In essence what is being reported is that the European Parliament may be preparing to reject some of the EMIR rule-making by ESMA. The story revolves around the interests of the real economy and the effectiveness of the exemption under EMIR from central clearing. There are references to fuel hedging by airlines, to there being a view within the Parliament that the clearing thresholds have been set too low and to the single asset class breach triggering clearing for all asset classes.

Some of us started to argue over three years ago that there should be an exemption for the real economy from the proposed regulatory approach on derivatives; at the beginning of the campaign we were opposed by every institution from the CFTC in Washington to the Commission and Parliament in Brussels. Whilst I will always be the first to recognise that the latter two were – to their credit – eventually prepared to listen and to change their positions, a huge amount of time and energy was spent to get us where we are today.

With the key exception of the asset class breach rules I consider the outcome in EMIR and the rule-making by ESMA to be essentially sensible and reasonable. I have no idea who is leading this initiative in Parliament – and the Reuters sources are of course anonymous. It would be mealy-mouthed to respond with a sigh, suggesting nonetheless that better late than never can still apply; but it would have been so much better if the EU institutions as a whole had been as sensitive to the interests of the real economy when they started to develop the original EMIR proposals.

We are where we are and I for one would rather that we could now move on to focus our energies on the various other financial regulatory initiatives that have implications for the real economy. Were it not for the continuing concern over the asset class breach rules I would consider debate over the arithmetic level of the clearing thresholds to be of academic interest only. Legitimate risk mitigation through derivatives was never intended to be caught and counted against any clearing threshold. But the issues around asset class breaches do complicate things and it would have been so much better if ESMA had been able to take on board the concerns expressed to them.

We’ll have to watch Parliament carefully, not least because the real economy seems to have some unexpected friends there. So what Reuters reports is probably good news even if its substance will surely mean that the whole implementation process of EMIR is even more protracted.

The Twelfth Night Basel announcement of a relaxation of the original proposals for the Liquidity Coverage Ratio (LCR) is interesting for the non-financial sector on at least two counts. But on two counts also it is challenging to write about the topic.

At one level raising doubts about the smartness as well as the detail of Basel’s proposals is a little akin to challenging motherhood or respect for the flag; we surely all want a more robust banking system, less capable of such egregious failures of prudence and basic competence than we have persistently seen over the last decades and most dramatically so in 2007/08.

The very complexity of Basel III and to lesser extents its predecessors creates the other challenge. No need for references to rocket scientists; all must know that mastering the detail of bank capital regulation is not for the faint-hearted nor for those whose daily lives are not directly touched by the subject.

So why does the LCR announcement look interesting to this layman?

Firstly, on the purely practical level the changes ease some of the pressures that Basel III imposes on the corporate world, quite apart from everything else happening in the economy beyond the financial sector. No need to repeat here the mantras about sustainable employment and growth being driven by the real economy, with productive capital investment delivering multiplier direct and indirect benefits.

Stay with me and I will simply note that in calculating the LCR banks need no longer make the theoretical and academic assumption that committed facilities will be 100% drawn within a 30 day period; the ratio is reduced to 30%. Common sense, you might be saying, but for evident reasons Basel is unmoved by mundane common sense.

The change in the basis for the LCR, taken together with the move to a phased introduction of the requirement (from 2015 to 2019), will be significant for the ability of banks to lend to the non-financial sector. As such we should welcome the proposals.

The second reason to be interested in the Basel announcement is I believe what it tells us about financial regulators and especially Basel and its community of central bankers. I first became involved with the implications of Basel III when we realised that it threatened to cut across the value of the corporate exemption from the G20 proposals (which would have shifted all OTC derivative transactions onto exchanges and into central clearing). I was told that the tablets of Basel were indeed immutably in stone; and I was told that Basel was an eco-system populated by central bankers with a resolute determination to talk to their own and certainly not to the non-financial sector.

I won’t rehash the story other than to say that – to the European Union’s credit – our arguments on the deleterious impact of CVA were heard and we believe we are now moving to an outcome on the EU’s implementation of Basel III (through CRD IV and CRR) that is sensible and valuable for the real economy.

The reaction to the news on LCR suggests that Basel actually listened – if not to our voice then at least to that of the banking sector. Rather too late perhaps……but Basel listened and recognised the argument.

Finally, some open questions that are I assume exercising minds in Brussels. Did the Commission have any inkling of the plans to soften the impact of the LCR requirement? Are the Commission, Parliament and Council now thinking through where this leaves the detail – in CRR – of the EU proposals? What now might be the timetable for implementation of CRR?

On the train to Paris to visit ESMA on Monday I drafted my own short list of the areas within EMIR (regulation of derivatives) where it is self-evident that the real economy needs help in understanding with what companies should be compliant in their use of derivatives. But what I have just written ought to read ‘….should have been compliant since 16 August 2012’ (see previous blog, ‘Derivatives regulation: is the real economy ready for implementation?’).

My list included:
– monitoring and complying with the principles of the exemption and clearing threshold;
– collateral exchange requirements;
– confirmation procedures;
– portfolio reconciliation procedures; and
– trade reporting requirements.

….and all of the above to be assimilated in the context of various deadlines for the implementation process.

I found the attitude at ESMA constructive and realistic. The pressures on the team are self-evident but I wasn’t filled with despair at the prospect of implementation being derailed by the sheer volume and complexity of the task.

So we talked about practicalities – and I know that such conversations are being repeated with many other representative bodies. ESMA sensibly looks to national regulators to carry on national dialogues, as we know, but is keen to have good links with organisations such as the EACT that can take a European wide view.

There is a real opportunity and need for the EACT to help the treasurers in its member associations by ensuring that there is clear advice on how to comply with EMIR. We won’t attempt to duplicate the output of ESMA, concentrating instead on providing input to the drafting by ESMA when appropriate and communicating through our own channels to draw attention to the guidance that is available.

Now for some good and some less good news. First the good. Not the least because the trade repositories are not yet in place to handle reporting under EMIR, there is no immediate requirement to comply with what EMIR demands in terms of trade reporting. I encourage everyone to look at Annex VII, Article 5 of ESMA’s RTS (draft technical standards) – you can access the document here. There are various dates specified by which trade reporting will get underway, with 1 July 2015 defined as the starting point for ESMA to receive the reports in the absence of a trade repository (presumably ESMA will be doing its best to ensure that the repositories are indeed all in place before that date looms).

And the bad news? In the meeting with ESMA we asked the question as to how derivative contracts outstanding at the commencement of EMIR – i.e. 16 August 2012 – but not outstanding at the point trade reporting kicks in should be treated. The somewhat bizarre answer is that all such contracts should still be reported within the timeframes specified!

I’m in no doubt that regulators will defend such a requirement but – if you start from my deeply sceptical position over the underlying relevance of any of this to reducing global financial systemic risk – you have to wonder what on earth will happen to all such historic data.

Finally – and following up on a reference in my previous blog – the format for reporting trade information is specified in Annex VI.I, Article 1, of the RTS. Happy reading.

As the derivatives regulatory bandwagon moves forward towards implementation it is unsurprising that the end users of derivatives – aka the real economy – should be encouraged to focus on what implementation of the new regulatory framework requires of them. Events with which I have been involved last Friday and will be tomorrow (12 November) have coincided to highlight for me that there are some significant issues to which treasurers should certainly be paying attention.

On Friday I was at a briefing session with HSBC, which included an excellent run-through of the EMIR background and brought home some of the uncertainties associated with its implementation. I won’t address here the detail of EMIR but simply mention two dates, one of which is in the past but merits some serious attention.

EMIR was passed into law on 16 August 2012. With effect from that date users of derivatives should be compliant with the regulation. There may already be some hollow laughs on the part of those reading this; whereas the large corporates will surely have been focusing on what EMIR means for them, it stretches reasonable credulity to suppose that companies that are not ‘large’ – and certainly the SME constituency – are well briefed on the implications of EMIR.

It’s of course fascinating that whilst EMIR is in legal force much of the practical details of the regulation remain to be confirmed. ESMA has produced its regulatory technical standards (RTS) but these are now being considered by the EU Commission and then have to pass through Parliament and Council. In broad terms this process should be finished by 31 March 2013. This might not matter were it not the case that there are some huge areas of detail included in the RTS that put the meat on the bones of what Brussels put into law back in August.

One could describe the current situation as akin to the EU having announced an entirely new sport and confirmed that, in order to win, a team must score more points. Some of the crucial details as to how one can score those points remain to be communicated.

So if you are a corporate end user and have stopped wringing your hands in despair, it might be worth noting that from 16 August 2012 you should have been in a position to report the copious detail that EMIR/ESMA requires on your derivative contracts to your trade repository. The fact that the trade repository does not exist is worth noting. HSBC stated that a draft format for trade repository reporting is available on the ESMA website (as I write I have not yet located the document).

It was clear from the Friday briefing that banking counterparties will be offering a trade reporting service to their corporate customers. There was some coyness on the part of HSBC as to what this might cost; it looks suspiciously like a vital service for which pricing control will clearly lie in the hands of the banks.

Oh and by the way, the contracts on which a corporate should have been reporting from 16 August 2012 are not just new contracts but also all those outstanding at that date.

The other date that might be worth noting is 1 July 2015. On that date if a trade repository (for the appropriate class of derivatives) is not in place in the relevant member state, then all the affected trades will be reported to ESMA. For those of us that have never been convinced about the systemic risk reduction benefits from real economy end users reporting their derivative trades, this raises the spectre of ESMA drowning in trade data for which the regulatory benefits are less than compelling.

Which brings me to what I am doing tomorrow, Monday. I’ll be in Paris for a meeting at ESMA, to discuss how the EACT can help raise end user awareness of the implications of EMIR. I’m greatly pleased that ESMA has suggested such a meeting, as it underlines that they recognise that the end users in which members of the EACT treasury associations work are completely unused to dealing with this type of financial regulation. This is of course even more the case with SMEs, as ESMA noted in setting up this meeting.

So I look forward to tomorrow’s meeting – and I’ll ask for help in identifying where the draft trading repository report format can be found.

Very interesting developments in the long-running saga of the Basel III implementation within the EU – our old friends CRD IV and CRR. The EACT and many corporates have been arguing that it is illogical and unhelpful to allow CRD IV/CRR to override economically the value of the corporate exemption under EMIR. The issue is specifically over the application of CVA, which in layman terms means how much additional margin is charged on uncleared bilateral OTC derivative contracts, to allow for the higher capital requirements proposed under Basel III and CRD IV/CRR.

When we started to argue that the EU should modify its implementation of Basel III we received essentially the same response that we had faced when we first started lobbying on the derivative regulations. That amounted to a polite (or on occasions, slightly less than polite) suggestion that we take our ball and go away and play elsewhere, as we were wasting our own and everyone else’s time. Naïvely or not we and others have persevered on both issues.

From the outset our argument on CRD IV/CRR has been that there should be a read-across exemption from CVA for EMIR exempt contracts – the economic effect of which would be to make it no more disadvantageous to benefit from the exemption. The first success was to obtain the support of ECON within the European Parliament. Since then the work on the proposals more or less disappeared into the mire that is officially described as ‘trialogue’; the latter is a process that often seems either extremely high-minded and democratic but sometimes looks to outsiders as crude nationalistic horse-trading at European level.

What I have been hearing in the last couple of days is that under the Cypriot presidency we are making real progress to obtain the read-across exemption for which we have been arguing. This is extremely good news for the real economy, even if there is a sting in the tail. That sting arises because the current proposal by Cyprus is to define the exemption in terms of whether or not the underlying transactions qualify for hedge accounting. In other words, the corporate would not be able to rely on the wider (and more sensible) approach under EMIR; that approach uses the test of whether a transaction is “objectively measurable as reducing risk”.

This is somewhat frustrating to see hedge accounting being brought back onto the table. On EMIR we had to argue early in the process that hedge accounting should not be the necessary condition for an exemption. Quite simply, this would be a nonsense for two reasons: firstly, there are sound risk mitigation reasons why on occasion companies will not be able to use hedge accounting; and secondly, it is inappropriate to base a regulation on transitory accounting standards.

On the assumption that what I have been hearing is indeed correct – and all the signs suggest that it is – we in the EACT will now vigorously pursue a campaign to confirm the read-across exemption and, most importantly, to explain why it is vital to remove the hedge accounting test.