Derivatives rules could come into force in March as European Parliament approves standards

The European Parliament withdrew an intended vote on two of the European Commission's draft regulatory technical standards made under its European Markets Infrastructure Regulation (EMIR) (238-page / 613KB PDF). Last week its Economic and Social Affairs Committee (ECON) raised concerns relating to some of the standards.

Once EMIR is in force all OTC derivative contracts between certain counterparties and of a type which falls into one of the classes to be specified under the regultaions will have to be cleared through central counterparties (CCPs). OTC derivative contracts which are not required to be centrally cleared will be subject to risk mitigation standards, while all derivative contracts, including those involving OTC derivatives, will have to be reported to central trade repositories to clear.

The rules, which will be subject to a three-year phasing-in period for non-financial companies, will likely be published in the Official Journal of the European Union (OJEU) in mid-March, according to Commissioner Michel Barnier. They will come into force 20 days after publication.

Banking law expert Stephen Woods of Pinsent Masons, the law firm behind Out-Law.com, said that approval of the standards was an "important step" for financial institutions and other organisations, such as pension funds, that use derivatives within Europe.

"There is a political angle to this because the European Commission needs to make sure its own regulatory framework ties in with the US equivalent, but it first had to accommodate the concerns raised on behalf of MEPs," he said.

"One key question is whether this chips away at the authority of the European Securities and Markets Authority (ESMA) to make technical rules under European financial services legislation. That may be is why the Commission has brokered a solution quickly rather than leaving Parliament to go ahead with the vote," he said.

Barnier is due to meet with US regulators this week to discuss whether EU-based firms that do business in the US will be able to meet regulatory requirements through compliance with their own regulatory regime.

"I will be able to reassure our American counterparts that the EU is meeting its G20 commitment on derivatives, and that we are now in a position to apply stringent rules in Europe that are equivalent to the ones in the USA," Barnier said in a statement. "With my visit I hope to make progress towards a system whereby the EU and the USA recognise the application of their respective rules on both sides of the Atlantic as equivalent."

A derivative is a type of financial contract linked to the underlying value of the asset to which it refers, such as the movement of interest rates or currency value, or the possible insolvency of a debtor. OTC derivatives are those not traded on a regulated exchange but instead privately negotiated between two parties. EMIR will apply to all derivatives trades which are not "executed on a regulated market" - over 95% of all such trades, according to EU figures.

EMIR was drafted as a response to the financial crisis and the collapse of major financial services firm Lehman Brothers in 2008. The firm was a leading player in the OTC derivatives market. The G20 group of major global economies, made up of 19 countries as well as the EU, agreed to introduce mandatory clearing in September 2009.

Pensions expert Mark Baker of Pinsent Masons said that the announcement would be of particular interest to pension schemes, many of which use derivatives as a way of limiting their exposure to financial risks. Pension schemes will be able to take advantage of a three year exeption from the clearing obligation under EMIR.

"Many pension schemes run by the country's largest employers use derivatives as a way of helping to limit their financial risk," Baker said. "Lobby groups succeeded in getting pension schemes a three-year exemption from the central clearing laws, but there is no certainty about whether that exemption will become permanent."

He added that the new rules could have the "knock-on effect of making it more expensive for pension schemes to use derivatives longer term" when combined with increased capital requirements due to come into force under the Basel III international banking agreement.