Esma’s Maijoor: Frontloading rule due in weeks

Frontloading causes "uncertainty" for market participants, says Esma chairman, Steven Maijoor, but he declines to comment on the substance of its forthcoming rule

Steven Maijoor, Esma

The European Securities and Markets Authority (Esma) will publish rules on frontloading within weeks, according to Esma chairman, Steven Maijoor, who adds that the regulator is aware of the pricing headaches the provisions are causing. Frontloading is a requirement of Europe's incoming swap clearing rules that can force existing trades to be passed to a clearing house, potentially altering their cost structure.

"It is beneficial to inform the market as quickly as possible, and we will publish our views within weeks," says Maijoor, speaking with Risk. "It has not been an easy process as it is a complex issue. The level one text of the European Market Infrastructure Regulation (Emir) requires frontloading, but we understand this causes uncertainty for market participants."

Risk reported earlier this month that European legislators had effectively agreed to sidestep the provisions, with Esma left to draft a rule and send a formal letter outlining the plans to the European Commission. Maijoor refused to comment on the approach the regulator will take.

Frontloading requires outstanding swaps to be cleared if they belong to a product class that is later mandated for clearing, which is a problem because cleared and non-cleared swaps have different capital and margining regimes, and could therefore have been mispriced at inception. The requirement only applies to trades that have a certain amount of time left to run – a minimum remaining maturity.

Members of the European Parliament (MEPs) told Risk that legislators had agreed at an April 3 meeting to set the maturity threshold high enough to exclude all outstanding trades.

It is beneficial to inform the market as quickly as possible, and we will publish our views within weeks

"The parliament agreed with the approach of both Esma and the commission that frontloading is causing huge problems for market participants, particularly end-users. Esma will now write a formal letter – to be published on its website – to the commission outlining that it will set the minimum remaining maturity at a sufficiently high level so as not to encapsulate any derivative contracts in the frontloading requirement," said a spokesman for UK MEP Sharon Bowles.

The industry has long argued that frontloading makes it impossible to price trades accurately. For example, if a US dollar swap is backed by euro collateral but is later novated to a clearing house, the trade would then have to be collateralised with dollars – central counterparties (CCPs) insist on the currency of the collateral matching the reference currency of the trade. This means the discount rate used to value the trade would change from the euro overnight index average (Eonia) to the Fed funds rate.

A frontloading window opens once a CCP has been authorised by its national regulator under Emir, in turn triggering a requirement for Esma to decide whether any of the CCP's suite of products are suitable for mandatory clearing – a process that can take up to 16 months. If a mandate is applied, existing trades would also be caught if they are above the minimum remaining maturity threshold, which Emir tells Esma to set, subject to the EC's approval.

Europe's first frontloading countdown was triggered by the authorisation of Nasdaq OMX on March 18, after it received approval from the Swedish regulator – Finansinspektionen – and Esma. Esma will now decide whether an EU-wide clearing obligation will apply to the products Nasdaq OMX has been licensed to clear, including euro-denominated interest rate swaps.

If Esma believes a mandate is appropriate, it has to draw up draft regulatory technical standards for the EC, which can either endorse or reject them. Approval is also required from the European Parliament and Council of the European Union. After this process, the frontloading window for a certain class of derivatives would begin from the day the CCP was authorised by its national authority – in this case on March 18. EuroCCP, Eurex, and KDPW_CCP have also been authorised by Esma.