What’s next for swaps clearing?

After nearly three years of negotiations, the European Market Infrastructure Regulation (Emir) 3.0 finally reaches the finish line, with implementation of the sticky issue of the active account requirement (AAR).

In its simplest terms, most firms now must have an account and actively clear Euro swaps at an EU-based clearing house. Firms who trade more than €3 billion (£2.6bn) in Euro-denominated interest rate swaps are required to clear five trades in relevant product categories.

But the devil is in the details. The AAR has exemptions and a fluid definition of relevant categories based on type, maturity and value, which makes the process of determining what trades are in-scope more difficult.

Clarity on who and what trades are in scope is paramount given how interest rate swaps are used in the wider economy.

They are one of the few financial contracts traded by non-financial firms. They play a critical role in helping large businesses manage their cashflow, at the same time these firms are not as well-versed in financial regulation as those in the industry.

Getting to grips with the AAR

From a more stringent percent-based requirement the European Commission first proposed, the rules now in effect are a compromise and a recognition that regulation alone will not drive more clearing to EU-based venues.

At best, a strict mandate would only cause firms to begrudgingly clear trades in the bloc. The EU must have attractive and commercially viable clearing options that meet the needs of a globally traded contract.

This is where clearing houses and the post-trade industry can help businesses in the “real economy” with the AAR to meet their regulatory obligations under Emir, while minimising its potential costs.

It is important to remember that Euro swaps are not traded in isolation. A firm trading a Euro swap may also have similar exposure to dollar, pound, or Swiss franc interest rate contracts. European traders may also hold swaps in EU currencies outside of the euro such as the Danish krone and Swedish krona.

This is on top of the many non-EU firms not subject to the AAR who also trade euro swaps. It is up to clearing houses and their members to provide solutions that minimise the regulatory cost coming from adhering to Emir.

The globalised swaps market makes cross-currency netting essential in limiting the financial impact of the AAR, preventing market fragmentation and a scenario where European traders become price takers instead of price makers in their home currency.

A clearing solution needs to address both the new regulatory obligations firms now face but also the commercial and operational factors that influence the swaps market. Most of all, good liquidity and a clearing fee structure that helps market participants mitigate the costs of moving clearing volume away from one large netting set.

The rules now in place are likely to be in force for the foreseeable future. While Emir 3.0 gives the European Securities and Markets Authority (Esma) the ability to redefine the product categories to ensure third-country concentration risk is being mitigated, the extensive effort taken by market participants to reach the current rules indicate that any revision of the AAR would involve another considerable consultation period with the industry.

Success of Emir 3.0 and the current AAR ruleset will come partly from the creation of market-driven solutions that help the EU meet its regulatory objectives while also addressing the needs of market participants.