Experts question frontloading necessity

Experts question frontloading necessity

The European Securities and Markets Authority (Esma) has recommended the mandatory clearing of certain OTC trades be delayed, possibly until around November this year.

Industry experts have told FOW however, that concerns still surround this introduction of frontloading relating to price differentials, valuations and operational risk.

With market participants growing increasingly concerned about the rules, some believe it should be scrapped altogether.

“Frontloading caused a lot of speculation and you could argue that it’s not needed at all,” said Hans-Ole Jochumsen, executive vice president, global market services for Nasdaq OMX.

“It’s interesting that the US tried to deal with this but shelved their plans and, so far, we’re the only region to consider it.”

Esma’s suggested relief to participants who would have had to clear some bilateral transactions came was deemed neccesary by the regulatory, following March’s approval of Nasdaq OMX’s clearing house which triggered the frontloading requirements.

Frontloading requires contracts concluded after March 18 to be subject to clearing obligations before their expiration date.

With Nasdaq’s approval under the European Market Infrastructure Regulation (Emir), equity, interest rate and commodity derivatives were all subject to the new rules, meaning they would have to be cleared at a later date.

“Esma’s proposals could effectively remove much of the requirement and we know the clarification will be welcomed,” added Jochumsen.

“Let’s remember this is just one of several issues to resolve around products, timings and process.”

Esma added that the effect of the frontloading rule would be a reduction in the incentive to hedge risks during a certain period, which would impact negatively on financial stability.

The regulator has therefore recommended the rules will apply only to contracts struck between the point when regulatory technical standards (RTS) kick in and the date of application of the clearing obligations.

This could give OTC participants relief between March and November, when RTS are predicted to take hold.

Virginie O'Shea, senior analyst, Aite Group, added that when the rules do take hold, the concern is the massive price differential between cleared and uncleared trades.

“Any trades happening in that period would have to be subject to clearing and at the moment to try and mitigate those issues they are saying we will have a threshold for the size of the trades which need to be cleared, but they haven’t said what the threshold will be,” she said.

“So that has got a lot of people worrying. There are a massive number of legal, financial and operational risks that firms will be facing if they are bringing this frontloading in.”

There is also concern surrounding whether the European Commission will take the recommendation from Esma.

In September last year, FOW reported that the Commission rejected Esma’s appeal to push back the trade reporting deadline, which was due to take hold this February.

This meant that when reporting rules came into force in February this year, many participants were not ready for the new regulation.

If the same stance was taken over frontloading, participants will be facing the clearing requirements sooner than planned.

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