By John Filar Atwood
The European Commission (EC) has proposed changes to the European Market Infrastructure Regulation (EMIR) that will provide for more robust supervision of central counterparties (CCPs). The reforms introduce a more pan-European approach to the supervision of EU CCPs to ensure further supervisory convergence and to ensure closer cooperation between supervisory authorities and central banks responsible for EU currencies.
For CCPs established in the EU, national authorities will exercise supervision in agreement with the European Securities and Markets Authority (ESMA). The proposal calls for ESMA to establish a new CCP Executive Session within ESMA that will be responsible for ensuring a more consistent supervision of EU CCPs, as well more robust supervision of CCPs in non-EU countries or third countries.
The existing colleges of national supervisors established under EMIR for each EU CCP will continue to act as bodies fostering cooperation and making joint decisions. The head of the new CCP Executive Session will chair the existing EMIR colleges in order to ensure consistency between the work of the Executive Session and that of the colleges.
Third country CCPs. The EC said in a news release that the proposals will enhance the recognition and supervision of third country CCPs to better address the potential risks to the EU’s financial stability. The reforms introduce a two-tier system for third-country CCPs under which non-systemically important CCPs will continue to operate under the existing EMIR equivalence framework.
Systemically important CCPs. Systemically important CCPs will be subject to stricter requirements. These requirements include compliance with the necessary prudential requirements for EU CCPs while taking into account third-country rules and confirmation from the relevant EU central banks that the CCP complies with any additional requirements set by those central banks. The additional requirements could include the availability or type of collateral held in a CCP, segregation requirements, and liquidity arrangements. A CCP also must agree to provide ESMA with all relevant information and to enable on-site inspections, as well as the necessary safeguards confirming that such arrangements are valid in the third country.
Depending on the significance of the third-country CCP’s activities for the EU and member states’ financial stability, the EC noted that a limited number of CCPs may be of such systemic importance that the requirements are deemed insufficient to mitigate the potential risks. In those cases, the EC, upon request by ESMA and in agreement with the relevant central bank, can decide that a CCP will only be able to provide services in the EU if it establishes itself in the EU.
The EC drafted the proposed reforms based on feedback from an extensive assessment of EMIR and two public consultations. The EC took into account input received on its communication responding to challenges for critical financial market infrastructures and to its staff working document on equivalence.
Rationale for reforms. Based on the feedback, the EC determined that amendments to the supervisory arrangements for EU and third-country CCPs under EMIR were needed for two reasons. First, while supervisory colleges enable information sharing among different supervisors, under current supervisory arrangements for EU CCPs the main decisions are ultimately made by the national authorities in the member states where the CCP is established. The EC believes this arrangement is no longer adequate given the volume of cross-border activity by CCPs and the potential risks for the EU financial system as a whole. In addition, the EC determined that the important role of central banks needs to be better reflected in the decision-making process.
The second reason relates to the fact that a significant amount of financial instruments denominated in the currencies of member states are cleared by recognized CCPs in non-EU countries as a result of the equivalence regime under EMIR. CCPs from those countries are allowed to operate in the EU following a thorough appraisal of third country’s rules by the EC and of the CCP by ESMA.
However, EMIR’s current rules on equivalence and recognition have demonstrated certain shortcomings with respect to ongoing supervision in third countries, which means that EU authorities may not become aware of new or growing risks to the EU financial system. In addition, the EC determined that the actions of a third-country CCP can have an impact on the financial stability of the EU and its member states and therefore raise significant concerns for EU central banks.
Impact of Brexit. The EC also noted that with the departure of the U.K. from the EU, CCP-related risks will be particularly exacerbated, as a substantial volume of derivatives transactions denominated in Euro or other EU member states currencies are currently cleared via CCPs located in the U.K.