EBA consults on draft technical standards for counterparty funding requirements

The European Banking Authority (EBA) has published a consultation (28-page / 441KB PDF) on the draft Regulatory Technical Standards (RTS) which will apply to central counterparties (CCPs) under the new regime. CCPs assume the counterparty risk during a trade between two parties, ensuring financial performance if one party does not meet its commitments.

The final version of the European Market Infrastructure Regulation (EMIR), which will bring mandatory clearing requirements into law, will be made available by the European Commission before August, the EBA said. The Commission published a revised draft (238-page / 613KB PDF) of the Regulation at the end of last week.

The draft RTS proposed for consultation will require a CCP to hold a minimum level of capital, including retained reserves and earnings, at all times. This must be at least equal to the sum of the CCP's operational expenses to cover an appropriate time span in the event that the CCP is wound down or restructured, and its capital requirements for its overall on- and off-trading book operational and market risks.

Under EMIR, which will come into force from next year, all OTC derivative contracts will have to be cleared through CCPs. In addition all derivative contracts, including OTC derivatives, will have to be reported to central 'trade repositories'.

The Commission drafted the new rules in the wake of the financial crisis and the collapse of major financial services firm Lehmann Brothers in 2008. The firm was a leading player in the OTC derivatives market. The G20 group of major global economies, which includes 19 countries as well as the European Union, agreed to introduce mandatory clearing from 1 January 2013 in September 2009 as a means of improving transparency in the derivatives trading markets and to protect against market abuse.

Although the European Commission remains on course to meet this target the head of its Financial Markets Infrastructure unit, Patrick Pearson, told a conference in London last month the Europe was likely to miss the deadline. Although the necessary legislation would likely be in place by the end of the year, the "lack of progress globally" would likely lead to the G20 revising its timetable.

Under EMIR, CCPs are required to maintain dedicated resources to cover their losses if one of their clearing members defaults on a trade. The draft RTS are intended to cover additional capital requirements enabling CCPs to mitigate against broader market risks relating to activities not covered by EMIR, as well as the operational risks arising from a CCP's other activities.

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 bankruptcy of a debtor. OTC derivatives are those not traded on a regulated stock exchange, but are instead privately negotiated between two parties. EMIR will apply to all derivatives trades which are not "executed on a regulated market" - over 95% of the derivatives market, according to EU figures.

The EBA intends to submit the final draft RTS to the European Commission by the end of September.