ISDA, the European Banking Federation, International Capital Market Association and the International Securities Lending Association (collectively, the "Associations") called for amendments to the European Market Infrastructure Regulation ("EMIR") to exempt certain transactions resulting from post-trade risk reduction services from mandatory clearing.
In a joint whitepaper, the four associations encouraged regulators to eliminate mandatory clearing as a disincentive to conducting risk-reducing post-trade portfolio compression and counterparty rebalancing exercises. According to the Associations, while European regulators recognize the value of these services, EMIR simultaneously disincentivizes many such exercises by requiring derivatives produced in such exercises to be cleared. Using hypothetical examples, the Associations attempt to show that multilateral compression exercises can be expanded and made more effective by introducing over-the-counter ("OTC") trades between a pair of participants that are offset by a cleared trade for the same pair. Because the new OTC trade would also be subject to mandatory clearing, these exercises may effectively be blocked. Similarly, the Associations note that the expansion of clearing may disrupt the ability to perform post-trade risk reduction exercises where offsetting trades are split between OTC and cleared trades or between two different CCPs. In these situations, the Associations advocate for the benefits of clearing exemptions from transactions created through counterparty rebalancing exercises.
The Associations acknowledge that exemptions for mandatory clearing may create possibilities for regulatory arbitrage. To avoid this, the Associations recommended that regulators require trades resulting from post-trade risk reduction services to (i) be market-risk neutral, (ii) be non-price forming, (iii) address second order portfolio risks, and (iv) be executed as integrated all-or-none packages.
Commentary / Jeff Robins
The examples in the whitepaper attempt to illustrate a non-intuitive message that exempting compression trades from mandatory clearing can facilitate additional transfers of risk from OTC books to clearinghouses. It is an informative read from that perspective. Its persuasiveness depends on whether one agrees that moving even more risk to clearinghouses is a good outcome (a question obliquely raised in a forward to the whitepaper).
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