Capital Markets: Derivatives 2024: Trends & Developments

Law and Practice

1. General

 1.1 Overview of Derivatives Markets

The UK's regulatory framework over the derivatives markets and products is currently made up of a mixture of UK domestic and EU-derived rules and regulations. The key pieces of legislation and regulations that impact the UK derivatives markets include the following:

• Financial Services and Markets Act 2000 (FSMA)– This is the cornerstone of UK financial regulation. The "general prohibition" therein states that a person carrying out specific activities in relation to specified investments, including derivatives, must be authorised to do so or have an exemption. The FSMA also places restrictions on financial promotions (ie, invitations or inducements to engage in investment activity).
• Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO) – This sets out the specified activities (eg, dealing as principal, arranging deals in investments) and specified investments that fall within the scope of the FSMA. Schedule 2 of the RAO lists 11 categories of financial instruments, with paragraphs 4–10 covering derivatives.
• European Market Infrastructure Regulation (EU EMIR) – Although originally an EU regulation, post-Brexit, the UK adopted EU EMIR into domestic law (UK EMIR). UK EMIR and EU EMIR focus on the regulation of derivatives and introduced a number of requirements relating to over-the-counter (OTC) derivatives. Among other things, UK EMIR and EU EMIR require the central clearing of standardised OTC derivatives, reporting of transactions in all derivatives to trade repositories, and implementation of risk mitigation techniques for non-cleared OTC derivatives. UK EMIR and EU EMIR have also been amended over the years, including by the UK and EU EMIR Refit.
• The European Markets in Financial Instruments Directive II and Markets in Financial Instruments Regulation (EU MiFIR) (together, EU MiFID II): Similar to EU EMIR, EU MiFID II was also onshored in the UK (largely through amendments to the FSMA and a retained version of EU MiFIR (UK MiFIR; together, UK MiFID II). These cover investment services and activities conducted in relation to financial instruments, including derivatives. UK MiFID II contains a number of significant measures relevant to derivatives, including requiring standardised derivatives to be executed on a trading venue, pre- and post-trade transparency requirements, and position limits for certain commodity derivatives. UK MiFIR also mandates the reporting of certain derivatives transactions.
• Regulation on Wholesale Energy Market Integrity and Transparency (UK REMIT) – UK REMIT applies to wholesale energy markets, covering contracts for the supply and transportation of electricity and natural gas, including derivatives. It includes obligations relating to registration, market abuse and reporting.

Derivatives can also fall within, or be affected by, a number of other legislative frameworks in the UK, including the Short Selling Regulation, Market Abuse Regulation, Benchmarks Regulation, Packaged Retail and Insurance-based Investment Products Regulation, Undertakings for Collective Investment in Transferable Securities (UCITS) Directive, Alternative Investment Fund Managers Directive, and capital rules.

 1.2 Historical and Forward-Looking Trends

Following the global financial crisis of 2007–08 and the 2009 G20 Pittsburgh Summit agreement to, among other things, clear all standardised OTC derivative contracts through a central counterparty (CCP), the EU adopted EU EMIR in 2012. EU EMIR was intended to increase transparency in the OTC derivatives markets, mitigate credit risk and reduce operational risk, and it had a significant impact on the EU derivatives landscape.

The UK's departure from the EU in January 2020 also hugely influenced the development of the derivatives markets in the UK. EU financial markets legislation, including EU EMIR, was largely onshored in the UK following Brexit by virtue of the European Union (Withdrawal) Act 2018. However, the UK government's intention was to repeal and replace the majority of EU law with the UK's own domestic rules over time.

The Financial Services and Markets Act 2023, published in July 2023, established the legislative framework for the revocation of all EU retained law relating to financial services and the transition to new requirements under the UK's FSMA regime. The UK's HM Treasury (HMT) states that it does not expect to commence the revocation of level 1 onshored EU legislation until the UK regulators have drafted and consulted on rules in the relevant areas that are ready to be enforced. It expects that it will take several years to complete the process of revoking retained EU law.

Despite the recent change in the UK government following the July 2024 election, it is likely that much of the next 12 months (and beyond) will be spent on the further repeal and replacement of retained EU law versions. Such replacements are not initially expected to be significantly different to the EU laws, but divergence is expected. Over time, as the EU amends its rules and regulations, further divergence between the UK and EU regimes can be expected. Ultimately, this could lead to increased compliance costs for international firms that might have to comply with both regimes. The implications of this for firms that are subject to both the UK and EU EMIR Refit.

As with other jurisdictions, ESG (ie, environmental, social and governance practices), operational resilience, and the use of new technologies such as artificial intelligence and distributed ledger technology are also all expected to have an impact on the development of the derivatives markets in the UK.

 2. Types of Derivatives

 2.1 Futures and Options

The UK does not use the term "futures" contract solely to refer to a derivative that must be traded on a UK-regulated market or an equivalent third-country market (ie, exchange). A futures contract can be traded both OTC as well as on a regulated market (ie, one that is registered with the Financial Conduct Authority (FCA)). Futures are defined in the RAO as "rights under a contract for the sale of a commodity or property of any other description under which delivery is to be made at a future date". However, such a contract will not fall within the definition of a futures contract when the contract is made for commercial rather than investment purposes. If such a contract is traded on a regulated market or third-country market, however, the contract will be deemed to be for investment purposes and will be a futures contract. The term "exchange-traded derivative" (ETD) is more frequently used in UK regulation to refer to derivatives traded on a UK-regulated market; however, the regulated markets themselves use the terms "futures" and "options on futures" to describe their products.

The UK currently only has five regulated markets, three of which are stock exchanges. The two non-stock exchanges, ICE Futures Europe (IFEU) and the London Metal Exchange (LME), both list various futures and options on futures across an array of asset classes. IFEU lists such products for energy, soft commodities, emissions, interest rates and securities. The LME lists such products for various metals including non-ferrous, ferrous and EV metals, and platinum.

In March 2024, the FCA stated that it would not object to requests from regulated markets to list crypto-asset-backed exchange-traded notes. Such trading is now available to institutional investors. There are also a handful of multilateral trading facilities (MTFs) that are approved by the FCA to offer trading in crypto derivatives. In January 2021, the FCA implemented a ban on UK firms offering or selling crypto derivatives and exchange-traded notes that reference certain types of crypto-assets to UK retail consumers.

 2.2 Swaps and Security-Based Swaps

In the UK, OTC derivatives (the financial instruments that are most similar to swaps and security-based swaps as defined under the US federal commodities and securities laws) that have underlying securities, as opposed to those on non-securities, do not have a distinct regulatory regime. Under UK EMIR, derivatives are linked to one of five applicable asset classes: (i) interest rates; (ii) foreign exchange (FX); (iii) commodities; (iv) equity; and (v) credit. The regulation of derivatives under UK EMIR does not differ based on the derivative's underlying asset class.

Cleared OTC derivatives are not regulated separately from uncleared OTC derivatives under UK EMIR. Most of the UK regulation applicable to cleared OTC derivatives under UK EMIR applies to the CCP and the clearing member.

 2.3 Forwards

Under UK regulation, a "forward" is considered to be a form of derivative (and therefore a regulated financial instrument) and is generally regulated in the same way as any other form of derivative. However, in the UK, FX forwards and physically settled commodity forwards are regulated differently to forwards on interest rate, cash-settled commodities, equities and credit.

OTC derivatives on a commodity that must be physically settled and cannot be cash-settled, and are not traded on a regulated market, an MTF or an organised trading facility (OTF) – together, a trading venue – generally fall outside of the definition of a financial instrument and are therefore not subject to UK regulation.

Physically settled FX forward contracts and physically settled FX swaps contracts, although still regarded as financial instruments, are not subject to the obligation to exchange variation margin (VM) if one of the counterparties to the OTC derivative is not a credit institution or would not be such an institution if it were to be established in the UK. It is not required that the initial margin (IM) be posted on physically settled FX forward contracts and FX swaps.

 2.4 Listed v Over-the-Counter

The regulation of derivatives under UK EMIR differs not by asset class but according to whether the derivative is an ETD or an OTC derivative. Derivatives can trade either bilaterally or on one of three types of regulated trading venues. If a derivative is traded on a regulated market, it is classified as an ETD (ie, listed). If a derivative trades on either an MTF or OTF, it is classified as an OTC derivative, as is any derivative agreed bilaterally between the two counterparties.

Under UK EMIR, both ETDs and OTC derivatives must be reported to an FCA-registered or -recognised trade repository. The other UK EMIR obligations are only applicable to OTC derivatives and include: (i) risk mitigation (including the uncleared margin rules (UMRs)); and (ii) mandatory clearing. The G20 obligation of requiring mandatory trading of any OTC derivative subject to a mandatory clearing obligation is provided for in UK MiFID II.

 2.5 Asset Classes

In the UK OTC derivatives market, interest rates are the largest traded asset class by a significant margin, with FX following as a distant second. Derivatives in the credit, equity and commodity asset classes represent a very modest share of the overall UK OTC derivatives market.

An emission allowance is a financial instrument under paragraph 11 of Schedule 2 of the RAO, but not a derivative. However, derivatives on emission allowances are included in the definition of a derivative in paragraph 4 of the RAO.

The UK is generally agnostic regarding the asset classes that can underlie a derivative contract. Paragraph 10 of Schedule 2 of the RAO includes a broad catch-all for evolving asset classes to include "any other derivative contracts relating to assets, rights, obligations, indices and measures not otherwise mentioned in this Section, which have the characteristics of other derivative financial instruments". The FCA does, however, ban the sale of certain derivatives to retail consumers including contracts for differences (CFDs) on equity securities and indices, commodities, FX and cryptocurrencies, spread bets and rolling spot FX transactions that qualify as financial instruments.

Derivative products related to crypto-assets and carbon credits (ie, UK allowances and voluntary carbon credits) are steadily increasing in size and liquidity.

 2.6 Exemptions, Non-derivative Products and Spot Transactions

As discussed in 2.3 Forwards, OTC commodity derivatives that must be physically settled and cannot be cash-settled, are not traded on a trading venue or equivalent third-country trading venues, or are equivalent to such transactions traded on such markets generally fall outside the definition of a financial instrument and therefore are out of scope of UK regulation, especially if one of the parties to the transaction is a supplier or producer of the commodity.

The UK does have a broad exemption for certain FX transactions that are either considered spot transactions or forward FX transactions connected to a payment transaction. Although an FX transaction involving two major currencies must be settled within two trading days to be considered a spot transaction, an FX transaction that is used for the main purpose of the sale or purchase of a transferable security or a unit in a collective investment taking will also be considered a spot transaction if it settles within the shorter of: (i) the period generally accepted in the market for the settlement of that security or unit as the standard delivery period; and (ii) five trading days. Additionally, an FX transaction involving the exchange of a non-major currency for either another non-major currency or a major currency will be considered a spot transaction if it settles within the longer of: (i) two trading days; and (ii) the period generally accepted in the market as the standard delivery period for that currency pair.

A physically settled FX forward contract will not be considered a financial instrument if: (i) it is used as a means of payment; (ii) it must be physically settled (other than for reasons of a default or other termination event); (iii) one of the parties is not a financial counterparty (FC); (iv) it is not traded on a trading venue; and (v) it is entered into to facilitate payment for identifiable goods or services, or for direct investment.

Physical spot commodities transactions do not fall within the definition of a financial instrument and therefore are not subject to UK regulation. A leveraged spot commodity, however, would fall under the CFD definition and is therefore banned by the FCA from being sold to UK retail market participants.

 3. Regulation of Derivatives

 3.1 National

 3.1.1 National Regulators

The Prudential Regulation Authority (PRA), which is part of the Bank of England, and the FCA are the UK regulators with primary responsibility for the supervision and oversight of derivatives market participants in the UK. The PRA's primary role is the authorisation and prudential regulation of banks, building societies and credit unions, whereas the FCA's primary role is to establish the business conduct standards that apply to derivatives market participants as well as the trading venues that list derivatives products for trading. The FCA is also responsible for the prudential supervision of firms that are not PRA-regulated.

Other UK regulators play an important role, too. The Bank of England supervises certain key market infrastructures that are vital to the derivatives markets, including CCPs and payment and settlement systems. In addition, the UK energy regulator, the Office of Gas and Electricity Markets, is responsible for the registration of market participants in the wholesale energy market, which also includes wholesale energy derivatives, under UK REMIT.

 3.1.2 Clearing

There are two independent derivatives-clearing obligations under UK law. Under the first obligation, all derivatives concluded on a UK-regulated market must be cleared at a CCP without exception.

Separately, the Bank of England is responsible for determining which standardised OTC derivatives must be cleared at a CCP; this list currently includes a number of interest rate and index credit default products. Whether the clearing obligation applies to an in-scope product depends on the nature of the counterparties to the transaction. Generally, transactions between some combination of FCs and/or non-financial counterparties (NFCs) that exceed the clearing threshold applicable to the relevant asset class (NFC+s) must be cleared unless an exemption applies. Relevant exemptions include qualifying intra-group transactions, which are subject to an application process with the FCA, as well as transactions by certain qualifying pension schemes. In addition, certain "small" FCs are not required to clear OTC derivatives transactions that are otherwise subject to mandatory clearing, provided they do not exceed the relevant clearing threshold.

FCs and NFCs must therefore determine on an annual basis whether, for a given asset class, their cleared and uncleared derivatives not executed on a UK-regulated market or a third-country exchange deemed to be equivalent by the FCA exceed the threshold applicable to a given asset class (currently EUR3 billion for interest rate, FX and commodities products, and EUR1 billion for credit and equity products). If a threshold is exceeded, the FC or NFC must begin clearing the relevant in-scope OTC derivatives within four months of crossing the relevant threshold(s). NFCs are permitted to exclude hedging transactions from the UK EMIR clearing threshold calculation. NFC+s are only required to clear OTC derivatives in the asset classes where they exceed the relevant threshold, whereas a "small" FC that exceeds the relevant threshold in any asset class must then clear OTC derivatives subject to a clearing obligation in all asset classes.

The Bank of England has the authority to suspend the clearing obligation in respect of one or more OTC derivatives, initially for a period not exceeding three months, where certain conditions are met. The suspension period may be renewed for successive three-month periods, up to a maximum of 12 months.

 3.1.3 Mandatory Trading

ETDs must by definition be concluded on a UK-regulated market or an equivalent third-country market.

In addition, the FCA may determine that an OTC derivative that is subject to a UK clearing obligation is also subject to a UK trading obligation, provided that the OTC derivative is traded, or admitted to trading, on at least one UK trading venue, and there is sufficient third-party buying and selling interest to support trading in the product. Where the UK trading obligation applies to an OTC derivative, in-scope FCs and NFC+s must conclude all transactions in such an OTC derivative on a UK trading venue, or on a third-country trading venue that is determined to be equivalent for the purposes of the trading obligation. Currently, only venues in Singapore and the United States regulated by the Commodity Futures Trading Commission benefit from such equivalence.

The UK rules are based on the derivatives' clearing and trading obligations working in tandem. This means, for example, that where the clearing obligation is suspended, any corresponding trading obligation is also suspended.

 3.1.4 Position Limits

Recent legislative amendments have removed the pre-existing MiFID II requirement that position limits must apply to all commodity derivatives traded on UK trading venues and their economic equivalents. Instead, the FCA has been granted the power to determine which exchange-traded commodity derivatives are subject to position limits.

To that end, the FCA has proposed to focus the UK position limits regime on so-called "critical contracts" (ie, those that are at the greatest risk from abusive practices or disorderly trading and where position limits and position management controls are most likely to mitigate such risks). The actual limits will be based on a market participant's overall net position in a given critical contract as well as its "related contracts", including cash-settled lookalikes as well as any other exchange-traded commodity derivative that can result in a position or delivery obligation in a critical contract, or another related contract, or where the settlement price is indirectly linked to the settlement price of the critical contract.

The FCA has set out its proposed framework for identifying critical contracts, which will be based on the following four criteria:

• physical versus cash settlement;
• the size and liquidity of the derivatives market compared to the underlying cash market;
• the type of underlying commodity; and
• the overall size of the market.

Where the FCA determines that a commodity derivative should be added to the list of critical contracts, market participants will have a 45-day notice period to submit comments, following which the determination will be amended or finalised. Trading venues will then have 30 days to establish the relevant limits.

Eligible firms may apply to the FCA for an exemption from an applicable position limit. The current UK framework provides non-financial firms with a so-called "hedging" exemption for positions that qualify as reducing risks relating to their commercial activities. The FCA has proposed to add a new "pass-through" hedging exemption for financial firms that facilitate hedging activities, as well as a further exemption for liquidity providers in critical contracts.

While not expressly required by UK law, many UK trading venues establish position accountability thresholds, which are set at a level below an applicable position limit, for the purpose of monitoring activity in the contract. Where a market participant crosses an accountability threshold, the trading venue's rules generally provide for certain supervisory responses by the venue, including the provision of information by the market participant. The trading venue often retains the right to require the market participant to reduce its position to below the accountability threshold.

 3.1.5 Reporting

Both UK EMIR and UK MiFIR impose reporting requirements on OTC derivatives transactions.

UK EMIR Derivatives Transaction Reporting

Article 9 of UK EMIR requires UK counterparties and CCPs to report all ETDs and OTC derivatives concluded, modified or terminated to a trade repository registered or recognised by the FCA by the following working day. Although UK-regulated counterparties are currently broadly required to notify the FCA when reporting errors occur, from 30 September 2024, due to UK EMIR Refit, all UK counterparties (including those that are unregulated) that are required to report under UK EMIR must notify the FCA (or in the case of CCPs, the Bank of England) of any material errors or omissions in their reporting as soon as they become aware of them. UK EMIR currently requires 129 reporting fields for each transaction reported, which will increase to 204 on 30 September 2024 due to the requirements under UK EMIR Refit.

UK EMIR requires double reporting. This means that both counterparties to a derivative are solely responsible and legally liable for reporting their side of the derivative with the exception that, due to the changes brought in by UK EMIR Refit, an FC is obliged to report both sides of the OTC derivatives it enters into with an end user that is an NFC below all UK EMIR clearing thresholds (NFC-), unless such NFC- determines to do its own reporting. Further, an NFC- is not required to report any OTC derivative transaction with a third-country entity that would be an FC were it to be established in the UK, where an equivalence decision for reporting has been made for that jurisdiction. In addition, UK EMIR, as amended by UK EMIR Refit, requires an alternative investment fund manager (AIFM) to report on behalf of its alternative investment fund (AIF), and the management company of UCITS to report on behalf of UCITS. Due to the fact that UK EMIR Refit has modified the definition of an FC to include both an AIFM and an AIF, a UK AIFM is required to report the OTC derivatives entered into by any of the third-country AIFs it manages, as well as for its UK AIFs. Delegated reporting is permitted under UK EMIR, but the UK counterparty with the UK EMIR reporting obligation remains solely responsible and legally liable for the reporting.

Due to the UK's back-to-back clearing model, an ETD can be required to be reported by multiple counterparties. For example, if an investment firm enters into an ETD through its clearing firm, which is cleared through a CCP, the investment firm, clearing firm and CCP will all be required to report the ETD for each part of the chain and side of the transaction they are involved in, resulting in four reports.

UK EMIR provides an exemption from the reporting obligation for intra-group transactions, which requires at least one counterparty to be an NFC (or that it would be if it were established in the UK) and notification to the FCA. The exemption additionally requires that:

• both counterparties are included in the same consolidation on a full basis;
• both counterparties are subject to appropriate centralised risk evaluation, measurement and control procedures; and
• the parent undertaking is not an FC.

UK MiFIR Transaction Reporting

UK MiFIR requires all UK investment firms to report transactions they execute in certain financial instruments to the FCA. Such reports must be made as soon as possible, and no later than the close of the next working day. The requirement applies to trades in financial instruments, including derivatives, to which any of the following criteria apply:

• they are admitted to trading or are traded on a UK, Gibraltar or EU trading venue;
• the underlying is a financial instrument traded on a UK, Gibraltar or EU trading venue; or
• the underlying is an index or basket composed of financial instruments traded on a UK, Gibraltar or EU trading venue.

"Transaction" and "execution" each have specific definitions for the purposes of the transaction reporting regime:

• "Transaction":
• • includes the purchase/sale of a financial instrument, entering into/closing out a derivative contract or an increase/decrease in the notional amount of a derivative contract; and
  • specifically excludes certain post-trade and settlement-related actions, including contracts arising exclusively for clearing or settlement purposes, the post-trade assignment or novation of a derivative contract and portfolio compressions.
• "Execution" includes the reception and transmission of orders (unless made in accordance with certain specified requirements), the execution of orders on behalf of clients, dealing on own account and making an investment decision in accordance with a discretionary mandate given by a client.

 3.1.6 Business Conduct

A number of business conduct requirements can apply to parties engaged in derivatives trading in the UK, depending on their status under UK EMIR (eg, FC or NFC) and their regulatory status.

The key conduct requirements under UK EMIR include:

• Margin requirements: Subject to certain exemptions and exceptions, UK EMIR margin requirements (VM and IM) generally apply where an FC or an NFC+ established in the UK enters into non-centrally cleared OTC derivative contracts with either another FC or NFC+, or a third-country counterparty that would be an FC or NFC+ if it were established in the UK.
• Risk mitigation techniques: FCs and NFCs must implement risk mitigation techniques for OTC derivative contracts not cleared by a CCP. These techniques include timely confirmation, portfolio reconciliation, portfolio compression, and dispute resolution processes.
• Mark-to-market and mark-to-model valuations: FCs and NFCs must perform daily mark-to-market valuations of their derivative positions. If market conditions prevent this, they must use reliable and prudent mark-to-model valuations.
• Reporting obligations: as discussed in 3.1.5 Reporting.
• Clearing obligations: as discussed in 3.1.2 Clearing.
• UK FCs, as authorised entities, can also be subject to the full range of requirements under, among other things, UK MiFID II and the FCA's Handbook. This includes the FCA's high-level principles, as well as specific requirements relating to, for instance:
• • financial promotions and client communications;
  • client classification and suitability;
  • conflicts of interest;
  • business continuity and outsourcing;
  • the FCA's senior managers and certification regime;
  • market conduct;
  • anti-money laundering, bribery and fraud; and
  • record-keeping.

 3.1.7 Commercial End Users

It would be prohibitively expensive for many end-users to have the middle- and back-office infrastructure to support compliance with the UK EMIR reporting, clearing and risk management obligations and the UK MiFID II trading obligations. Therefore, UK EMIR, including as amended by UK EMIR Refit, provides substantial relief for those end users who are NFC-s. UK FCs must now report, on behalf of the NFC-, any OTC derivative transaction they enter into with an NFC- unless the NFC- determines to do its own reporting. Further, NFC-s are no longer required to report the OTC derivatives transaction they enter into with third-country entities that would be FCs were they established in the UK, provided a reporting equivalence decision has been made for that jurisdiction. NFC-s are exempt from both UK EMIR clearing and UMRs. NFC-s are, however, subject to the UK EMIR risk mitigation obligation, which requires portfolio reconciliation, dispute resolution and portfolio compression (if certain thresholds are met). However, such compliance obligations in general are more burdensome to the FC than to an NFC-; for instance, an NFC- can elect to be a receiving entity and not a sending entity for the purposes of the portfolio reconciliation obligation.

In contrast, NFC+s are equally subject to all UK EMIR obligations as an FC above one or more clearing thresholds (FC+). However, certain UK EMIR exemptions apply for NFC groups, regardless of whether the NFC is an NFC-. As discussed in 3.1.5 Reporting, an exemption from UK EMIR reporting exists when, among other conditions, one party to the OTC derivative transaction is an NFC and the parent undertaking of the group is not an FC. An intra-group exemption from both the UK EMIR clearing obligation and margin obligation for uncleared OTC derivatives exists for NFCs (and FCs) provided an application is filed with and granted by the FCA.

 3.2 Local

UK regulation of the derivatives markets and market participants occurs solely at the national level.

 3.3 Self-Regulatory Organisations, Independent Authorities, and Exchanges

The UK derivatives regulatory regime does not have any "self-regulatory organisations" with quasi-statutory rulemaking authority akin to the US National Futures Association, nor do UK trading venues have the authority to establish or enforce any industry-wide standards or regulations.

 4. Documentation Issues

 4.1 Trading Documentation

 4.1.1 Industry Standards and Master Agreements

Uncleared OTC Derivatives

Uncleared OTC derivatives are commonly governed by the standard agreements published by International Swaps and Derivatives Association, Inc. (ISDA), regardless of product type and counterparty, and are generally governed by either English or New York law.

As part of ISDA's aim to streamline derivatives documents, it has developed a standardised framework of documentation for derivatives transactions. Such documents include:

• the 1992 and 2002 master agreements – a preprinted framework document comprised of boilerplate provisions;
• the schedule to the master agreement – amends the terms of the master agreement as agreed by the parties;
• the credit support document – an optional document that offers each party security against the other party's credit risk, either in the form of:
• • a credit support annex (CSA); or
  • a credit support deed (CSD); and
• the confirmation – sets out the economic terms of an individual trade.

The master agreement, schedule, CSA (if any) and all confirmations form one single contract. The CSD (if any) is a standalone document.

Cleared OTC Derivatives

Cleared OTC derivatives can also be documented under standard ISDA documentation. However, frequently, a Futures Industry Association (FIA)–ISDA Cleared Derivatives Execution Agreement is used instead of negotiating a full ISDA. Additionally, an FIA–ISDA Cleared Derivatives Addendum is generally used to document the relationship between a clearing member and its client. However, there can be practical differences between the documentation process for cleared and uncleared OTC derivatives. For example, the cleared OTC derivatives documentation process is generally heavily dependent on automated information technology processes. Additionally, the terms of cleared OTC derivatives documents must conform to the relevant clearing house's contract specifications.

ETDs

The parties involved in ETDs do not execute bilateral derivatives documentation, such as the standard ISDA documentation, but are subject to the rules of the underlying exchange.

ETDs are generally governed by standard documentation in line with the exchange's contract specifications, as applied through the exchange's rules. If a party to an ETD is not itself a member of the exchange, it will be required by its clearing firm and/or brokerage firm to negotiate a clearing/brokerage agreement, which is generally bespoke to each such firm.

 4.1.2 Margins

ISDA has produced standard credit support documents that take the form of either a CSA or a CSD. Generally, the governing law of the credit support document matches the governing law of the ISDA master agreement (although this is not mandatory).

VM

In 2016, ISDA introduced a new CSA for VM that is used for documenting the posting of VM under English law (2016 VM CSA). The 2016 VM CSA forms part of a suite of credit support documents introduced to aid compliance with margin requirements for derivatives that are not subject to mandatory clearing under UK EMIR and comparable legislation in other major financial jurisdictions.

The 2016 VM CSA revises the 1995 ISDA CSA (Bilateral Form–Transfer) (1995 CSA) to allow parties to determine VM arrangements that meet the regulatory requirements for uncleared derivatives (ie, UMRs) that entered into force in March 2017. The structure of the 2016 VM CSA remains consistent with the 1995 CSA. The updates in the 2016 VM CSA relate solely to VM. ISDA has also published a 2016 VM CSA under New York law.

ISDA has also published the 2016 Variation Margin Protocol to help market participants comply with the VM requirements of the UMRs. This enables market participants to amend their CSAs with multiple counterparties to be compliant under the UMRs.

IM

Under UK EMIR, as further detailed in the UMRs, parties to a derivatives agreement are required to post IM if they have uncleared derivatives portfolios with an aggregate average notional amount exceeding certain thresholds.

At a minimum, parties will likely need the following suite of documentation regarding the posting of IM:

• a collateral agreement between the parties – the relevant CSA, CSD or collateral transfer agreement and security agreement (where posted collateral is held outside of the UK or with Euroclear/Clearstream);
• an account control agreement – a tripartite agreement between the parties and the custodian, which sets out control and access provisions in accordance with the relevant segregation requirements under the applicable margin rules;
• an eligible collateral schedule between the parties;
• a custody agreement between a party and the custodian; and
• a Euroclear/Clearstream representative agreement – required where the counterparty posts IM via Euroclear/Clearstream.

 4.1.3 Other Agreements

Global Master Repurchase Agreement (GMRA)

While repurchase (repo) transactions can be documented individually, they are usually documented under a master agreement. The International Capital Market Association (ICMA) and the Securities Industry and Financial Markets Association (SIFMA) have published standard forms of the repo master agreement, namely, the GMRA.

The 2011 version of the GMRA is generally used to document non-US repo transactions.

The GMRA is comprised of three parts:

• Standard boilerplate legal and credit provisions: These include warranties, events of default, margining provisions and netting provisions.
• Annexes: Annex I allows the parties to modify the boilerplate provisions of the GMRA, and certain other annexes can be added to cover particular types of security.
• Confirmation: This contains the commercial terms of each repo transaction.

Global Master Securities Lending Agreement (GMSLA)

Securities lending transactions are usually documented by the GMSLA, which is a market standard master agreement produced by the International Securities Lending Association (ISLA). The ISLA is a trade association representing the interests of participants in the securities lending market.

The GMSLA was originally drafted to comply with English law on securities lending. It has been developed as a market standard for securities lending and sets out the obligations of the borrower and the lender. It is now recognised as the most-used agreement in the UK and EU bilateral securities lending market. While various versions of the GMSLA exist, the 2010 version is the most widely used for new trading relationships.

The GMSLA is comprised of the following parts:

• Master agreement – the preprinted form;
• Schedule – where the parties can amend the preprinted form;
• Confirmation – sets out the economic terms of individual securities lending transactions; and
• Annexes and addendums – there are various annexes and addendums that the parties might agree to attach to the GMSLA (eg, the agency annex and an addendum for pooled principal agency loans).

Master Repurchase Agreement (MRA)

The MRA, published by SIFMA, is the primary form of standardised repo agreement used for US repo transactions. The latest version of the MRA was published in 1996 by SIFMA.

Master Securities Lending Agreement (MSLA)

The MSLA, published by SIFMA, is the primary form of standardised agreement used for US securities or stock lending transactions.

Master Securities Forward Transaction Agreement (MSFTA)

The MSFTA, published by SIFMA, is the primary form of standardised agreement used to document a US securities forward transaction that is subject to margin requirements under Financial Industry Regulatory Authority Rule 4210.

 4.2 Clearing Documentation

In summary, the following documents may be relevant in respect of cleared derivatives.

• CCP rulebook and procedures:  These set out details in relation to access to clearing and how clearing works.
• Clearing agreement between the clearing member and the client: The terms on which contracts are cleared are stipulated in the clearing house's standard clearing agreement. The FIA has published terms of business that are commonly used to document this relationship.
• Collateral agreement in relation to the cleared transactions: Pursuant to this the client will provide IM and VM to the clearing member, who then posts IM and VM to the CCP.
• Other ancillary agreements between the clearing member and client: These include engagement letters and service and licensing agreements.
• Indirect clearing documentation between the clearing member and client: This documents indirect clearing services to the client. The FIA has published a number of industry-standard documents to help firms comply with the indirect clearing requirements.

 4.3 Opinions and Other Documentation Issues

While legal opinions are not generally required by regulation in this jurisdiction for entering into derivatives under trading agreements, various opinions and other documents in this section are widely used in the derivatives market and have been issued for this jurisdiction.

ISDA opinions

ISDA has published a number of legal opinions covering various issues and jurisdictions. Such opinions include, among others, netting opinions, collateral opinions, international financial institutions opinions and client clearing opinions. To the degree that a UK counterparty is not covered under the UK ISDA netting or collateral opinion, it is likely its counterparty would request an opinion relating to the UK counterparty's capacity and authority to enter into the transaction, as well as a netting and collateral opinion.

ISDA Netting and Collateral Opinions

ISDA has commissioned netting opinions in over 80 jurisdictions and collateral opinions in over 60 jurisdictions, including for England and Wales. These opinions are available to ISDA members and are generally updated on an annual basis.

The ISDA netting opinions address the enforceability of the termination, bilateral close-out netting and multibranch netting provisions of the 1992 and 2002 ISDA master agreements. The collateral opinions examine the enforceability of the ISDA credit support documents in different jurisdictions. The ISDA England and Wales netting and collateral opinions currently consider the following English entities (as defined in such opinions, as necessary): (i) corporations; (ii) friendly societies; (iii) co-operative or community benefits societies; (iv) statutory corporations; (v) chartered corporations; (vi) banks/credit institutions; (vii) investment firms; (viii) building societies; (ix) banking group companies and bank holding companies; (x) trustees of English trusts; (xi) insurance companies; (xii) charities; (xiii) pension funds; (xiv) investment funds; (xv) partnerships; (xvi) Standard Chartered Bank; (xvii) the Bank of England (only considered in the netting opinion); and (xviii) the UK acting through HMT (only considered in the netting opinion).

ISDA Protocols

ISDA has published various contractual amendment mechanisms that enable parties to enter into standardised amendments through adhering to relevant protocol agreements with counterparties. Generally, ISDA publish these protocols in response to regulatory, technological and market developments. The ISDA protocols relating to the UK include:

• the ISDA 2020 UK EMIR Portfolio Reconciliation, Dispute Resolution and Disclosure Protocol;
• the ISDA 2020 UK (PRA Rule) Jurisdictional Module to the ISDA Resolution Stay Jurisdictional Modular Protocol;
• the ISDA 2016 Bail-in Article 55 BRRD Protocol; and
• the ISDA 2013 EMIR NFC Representation Protocol.

 5. Enforcement Trends

 5.1 Regulator Priorities and Enforcement Trends

UK EMIR Derivatives Reporting Enforcement

To date, the FCA has only taken one enforcement action in October 2017 in respect of UK EMIR transaction reporting, which was in respect of ETDs. Such action was against a large financial institution for breach of the transaction reporting requirements under Article 9 of UK EMIR and Principle 3 of the FCA's Principles for Businesses in the FCA Handbook. The FCA noted that this was the first enforcement action against a firm for failing to report details of trading in ETDs under UK EMIR.

UK MiFID II Transaction Reporting in Respect of Derivatives

In contrast, the FCA has been more active in taking enforcement actions against UK firms for failure to report transactions under UK MiFID II, and the predecessor regime under the original Markets in Financial Instruments Directive that entered into force in 2007.

To date, the FCA has fined 14 firms for MiFID transaction-reporting breaches. In 2019, the FCA fined a large financial institution GBP34.3 million for failing to provide accurate and timely reporting relating to 220.2 million transaction reports. This is the most recent FCA fine relating to MiFID transaction reporting.

As a result of UK EMIR Refit, there are several new reporting standards under UK EMIR (including an increase in the number of reporting fields from 129 to 204) coming into effect on 30 September 2024 in the UK. While it is expected that the FCA will take a lenient approach for a requisite time period for transaction-reporting errors relating to UK EMIR Refit, the FCA will continue to take a strict approach in regard to any transaction-reporting breaches under UK MiFID II.

FCA's Key Priorities

The FCA publishes an annual business plan detailing the work that it intends to complete over the next 12 months. The FCA's business plan for 2024–25 explains that the FCA will continue to deliver on its 13 public commitments, focusing on:

• reducing and preventing financial crime;
• putting consumers' needs first; and
• strengthening the UK's position in global wholesale markets.

Separately, the FCA regularly publishes its Market Watch newsletter. This is the FCA's newsletter on market abuse risks, transaction reporting issues and other market conduct issues. The newsletter aims to assist market participants in understanding such areas and considering the relevant related practices.