EU announces its plan to reduce reliance on third-country CCPs: the “active” account requirement

At a glance

• The European Commission (“Commission”) has published its final proposal for amending EMIR to increase the attractiveness of EU-based CCPs and reduce the EU’s “over-reliance” on UK-based clearing services following its February consultation.
• This is a significant milestone in the EU’s strategy to secure “open strategic autonomy” for its financial markets: reducing “excessive exposures” to systemic third‑country CCPs was a priority in the Commission’s “fostering openness, strength and resilience” strategy.
• The key measure proposed is to require EU‑based firms subject to the clearing obligation to maintain an “active” account at an EU CCP, although the Commission proposes to entrust ESMA, in cooperation with the EBA, EIOPA and the ESRB (and after having consulted the ESCB) with defining “active”.
• In parallel the Commission has proposed changes to the CRD and the IFD. These changes mandate firms to produce plans to meet the active account requirement and empower competent authorities to take steps where firms fall short.
• The outcome that the Commission seeks is that the clearing services offered by UK CCPs should cease to be of substantial systemic importance. The key question is whether the Commission’s proposal will be sufficient to achieve that aim, given that EU-based firms’ clearing clients have historically been reluctant to move away from using UK‑based CCPs.
• Despite the lack of any detail about what constitutes an active account, firms should nevertheless spend time understanding the scope of the changes and what sort of client engagement and outreach activities will be needed to implement them. It may be that firms end up with relatively little time in which to comply with the Commission’s package.

Relavent to:

CROs, CCOs, CFOs and Heads of Derivatives trading at financial counterparties, executives at non-financial counterparties which are active in the affected derivative markets.

Background

Despite the UK’s departure from the EU, London continues to have a very significant share of the clearing of certain EU products: EUR-denominated interest rate derivatives and CDS and PLN-denominated interest rate derivatives. ESMA has identified these services as being of “substantial systemic importance” to the EU or to one or more Member State. The potential financial stability risks that might have crystallised had the EU suddenly withdrawn access for EU-based firms to UK CCPs, and the lack of progress in onshoring EUR-denominated clearing activity, led to the Commission sequentially granting UK CCPs a series of temporary equivalence decisions, now lasting until June 2025.

Alongside the Commission’s last announcement of temporary equivalence for UK CCPs in February 2022, it also launched a consultation on a range of measures designed to reduce the EU’s “over-reliance” on UK CCPs. Many of the measures considered were substantial and, if adopted, would have either forced or heavily incentivised EU‑based firms to relocate clearing activity in the relevant products to the EU. This included effectively preventing firms from clearing through third‑country Tier 2 CCPs (all of which are currently UK-based).

On Wednesday, 7 December 2022, the Commission released its final package of measures to increase the attractiveness of EU‑based CCPs. This comprises a series of amendments to the European Market Infrastructure Regulation (EMIR) and an associated proposal to amend the Capital Requirements Directive (CRD) and the Investment Firms Directive (IFD) in relation to concentration limits for exposures to CCPs.

This blog assesses the Commission’s proposals as they relate to third‑country CCPs, their implications for clearing members and their clients and what the next steps are on the path to finalisation and implementation. The EMIR proposal also includes a range of other measures designed to improve the attractiveness of EU-based CCPs and how they manage risks, including margin calls. We do not cover these wider issues in this analysis.

Key Elements of the Commission's proposal

The Commission’s EMIR proposal introduces a requirement for both financial and non-financial counterparties subject to the clearing obligation to hold active accounts at EU-based CCPs and to report their activities on these accounts to their competent authorities. However, the Commission has largely left defining active to ESMA (in cooperation with the EBA, EIOPA and the ESRB, and after having consulted the ESCB). However, the Commission has set a clear outcome: the eventual criteria for an active account must result in the relevant third‑country clearing services ceasing to be of substantial systemic importance.

Article 25 (2c) of EMIR sets out considerations for assessing substantial systemic importance (including the size of credit and liquidity exposures of EU participants, non-prefunded losses in case recovery or resolution plans are triggered and the impact of non-access to services), but there are no clear quantitative thresholds. February’s consultation suggested the Commission was open to criteria ranging from a quantitative amount calculated annually to a qualitative definition. However, we expect ESMA to propose a definition based on volumes of activity – this will enable it and the firms concerned to monitor progress. February’s consultation also raised the possibility of the criteria evolving over time, presumably accounting for an increasing proportion of a firm’s clearing activity. In response, firms should evaluate how active account requirements of differing strengths could affect their business models and plan for the initial minimum requirement to rise in the years after it is announced.

The active account requirement will only apply to clearing services which are considered of substantial systemic importance. However, the Commission will be able to add any new products to the list for which an active account is required whenever ESMA recognises a new substantially systemically important clearing service provided by a Tier 2 CCP.

The Commission’s proposal notes that 60% of the EU clients of EU clearing members already have an account for clearing interest rate swaps at an EU CCP, and roughly 85% have one for CDS, which will somewhat mitigate the operational transition. However, this proposal, unlike the February consultation, does not address the issue of omnibus client accounts, where clients’ positions are aggregated. These and other important issues are likely to be picked up by ESMA when it comes to define what constitutes an active account.

The EMIR proposal sets out the “end” – that the relevant third‑country clearing services should cease to be of substantial systemic importance. The active account requirement is one means to achieve this end. The other is the proposed changes to the CRD and IFD which:

• require the management bodies of banks and investment firms to manage concentration risks arising from their exposures to CCPs, consistent with the need to hold an active account, and develop plans and targets to achieve whatever reduction in clearing activity in third‑country CCPs is set by ESMA’s definition of an active account;
• empower competent authorities to assess firms’ management of concentration risks arising from their exposures to CCPs; and
• empower competent authorities to require firms to reduce exposures towards a CCP or to realign their exposures consistent with the active account requirement, where there is an “excessive concentration risk” to a CCP.

The EBA will be asked to develop guidelines to ensure that competent authorities adopt a consistent methodology for integrating concentration risk into supervisory stress testing.

The Commission’s proposal notes that “Whilst competent authorities can already impose additional own funds requirements for risks that are not or not adequately covered by the existing capital requirements, they should be better equipped with additional, more granular, tools and powers under the Pillar 2 to enable them to take suitable and decisive actions based on the conclusions of their supervisory assessments.” This leaves us in little doubt that the Commission intends competent authorities to use these powers proactively in order to reduce EU‑based firms’ reliance on UK‑based CCPs.

The key question is whether the Commission’s proposal will be sufficient to achieve its outcome that UK-based CCPs should cease to be of substantial systemic importance, given that EU-based firms’ clearing clients have historically been reluctant to move away from using UK‑based CCPs.

Potential implementation timing and next step

The Commission’s proposal contains a series of interim milestones which add to a list of existing CCP-related commitments. This makes for a very busy period ahead in terms of reviews and new policies relating to the regulation of CCPs:

• The Commission proposes that ESMA indicate “suitable” phase-in periods for progressive implementation of the active account requirement, which we assume will aim to conclude with full compliance at the expiry of equivalence in June 2025.
• In the interim, ESMA is to announce within a year of the proposals entering into force the criteria for the active account and the reporting mechanisms.
  • ESMA will finalise the implementation of its supervisory approach for third‑country CCPs by end-2023, of which Tier 2 CCP supervision will be a key dimension.
  • EMIR mandates a general review of EMIR in 2024 focused on the overall functioning of the EU and third-country CCP framework with a view to (amongst other things) assessing whether the level of risk exposures remaining at UK CCPs or other large Tier 1 CCPs have decreased sufficiently, as well as providing deeper long-term reflections on cross-border risks.
• In anticipation of the eventual package being agreed by co-legislators, ESMA also promised to adopt a “renewed strategy” for CCPs and ensure it is implemented before June 2025.

If the Commission’s ambition is for the clearing services provided by UK CCPs to cease to be of substantial systemic importance by June 2025 (when the current temporary equivalence expires), the timetable seems very tight. As noted above, the EMIR proposal goes well beyond the treatment of third-country CCPs and, as we have seen in the past, measures that involve changes to the powers of national competent authorities in relation to EU CCPs are complex and therefore take time to negotiate. Firms subject to the active account requirement may find themselves with relatively little time to comply. Despite the lack of detail about what constitutes an active account, firms should spend time understanding the scope of changes and what sort of client engagement and outreach activities will be needed to implement them.