While supporting the objectives of the EU Regulation on OTC
Derivatives, a global hedge fund association said that the central legislative
principles of risk mitigation, transparency and enhanced competition
necessitate a mandate for real time acceptance or rejection for clearing of OTC
derivatives contracts immediately following execution. In a letter to the European
Securities and Markets Authority ESMA), which has proposed standards
implementing the European Market Infrastructure Regulation (EMIR), the
Alternative Investment Management Association reasoned that allowing extensive
periods to pass between execution and submission to a central counterparty
would cause numerous market inefficiencies, including unnecessary exposure to
counterparty credit risk leading to consolidation of the sell-side market among
a few large participants and a corresponding increase in systemic risk.
The association also noted straight through processing would
provide extensive competition benefits since participants would be able to
execute with a larger number of counterparties due to the removal of counterparty
credit exposure and, as a result, compress bid-offer spreads for all
participants. It is also implicitly linked to the regulatory initiative to move
OTC derivatives to regulated trading platforms. Without straight through processing, cautioned the
hedge fund association, OTC derivatives will not be able to make the transition
to truly electronic execution with anonymous central limit order books.
With the emphasis on cross-border coordination of
derivatives regulation, it is also important to note that straight through
processing has been explicitly mandated in the US by recent CFTC rulemaking. The majority of central counterparties and dealers
within the EU will, therefore, already be implementing the necessary
operational procedures to perform straight through processing.
The association supports EMIR’s governance provisions for central
counterparties, particularly the inclusion of client representation on the
governance of central counterparties. Moreover, eEchoing a comment letter from
the Managed Funds Association, AIMA said it is important to adopt measures
preventing the circumvention of these governance provisions. Also similar to
MFA concerns, the association urged ESMA to consult as soon as reasonably possible
on the cross-border issues around derivatives regulation, including derivatives
contracts with a direct, significant and foreseeable effect within the EU.
AIMA is concerned that the implementation of the mandatory
clearing obligation may result in certain netting-sets being inadvertently
split, due to the second contract being un-clearable at the time, and so
imposing additional market, legal and operational risk on participants. The
group asked that the application of the mandatory clearing obligation to
specific contracts consider any adjacent unclearable contracts within
netting-sets.
The association is also concerned that the concept of liquidity
fragmentation could be used by central counterpaties for anticompetitive purposes.
Thus, ESMA was urged to define liquidity fragmentation in clear and absolute
terms subject to a very narrow interpretation limiting it to only the most
exceptional of circumstances.