On 13 June, the European Commission released the second set of proposed amendments to the European Markets Infrastructure Regulation (EMIR) on the recognition and supervision of third-country CCPs.
The proposal represents a fundamental overhaul of the EU’s approach to the recognition and supervision of third-country CCPs (the UK will be a ‘third country’ once it leaves the EU and assuming it does not join the EEA). It includes extensive and intrusive supervisory and enforcement powers for the European Securities and Markets Authority (ESMA), a significant new role for the European Central Bank (ECB) and an ability to require the most systemically significant third-country CCPs to establish themselves in the EU as a condition for providing their clearing services to EU clearing members and their EU clients. Overall the framework provides ESMA, the Commission and the ECB with very wide-ranging discretion in relation to third-country CCPs.
Please find below a summary of the proposals and implications for capital markets participants. The table provides an overview of the rules around recognition, authorisation and supervision of third-country and EU CCPs, the institution responsible for making the decision in each case and the role of central banks.
Amendments to the recognition of third country CCPs
ESMA to gain significant powers in relation to CCP authorisation and supervision
Although the Commission will continue to determine the equivalence of third-country CCP regimes, ESMA will gain more powers in assessing and approving third country CCPs to provide clearing services for trades subject to the EMIR scope.
In practice, ESMA will be able to differentiate between three categories of CCPs based on their systemic importance (see below). ‘Tier 1’ CCPs will include third-country CCPs that ESMA has determined as non-systemically important or not likely to become systemically important for the EU. These Tier 1 CCPs will continue to be subject to the current arrangements for third-country equivalence decisions adopted by the Commission, while ESMA will be tasked with new responsibilities regarding their supervision.
Third-country CCPs which are deemed to be systemically important or likely to become systemically important in the near future for the financial and economic stability of the EU will be categorised as ‘Tier 2’ CCPs. The Tier 2 CCP determination will be based on four criteria:
- The nature, size and complexity of the third-country CCP's business.
- The effect that the failure of, or a disruption to, the third-country CCP would have on the financial stability of the EU.
- The third-country CCP's clearing membership structure.
- The third-country CCP's relationship, interdependencies, or other interactions with other financial market infrastructures.
It is important to note that at present the criteria have no quantitative thresholds or metrics. The Commission must publish a regulatory technical standard six months after adoption of the proposed Regulation which will presumably give further information of the considerations that will inform its own and ESMA’s decision-making. The criteria, as drafted, refer to financial stability in the broadest terms.
Tier 2 CCPs can only be recognised if they meet further conditions, including:
- Ongoing compliance with the relevant and necessary prudential requirements for EU CCPs as set out in EMIR. The proposal envisages a new system of ‘comparable compliance’ if the requirements in the CCP’s home country produce an outcome comparable to EMIR.
- Written confirmation from the relevant EU central banks of issue that the third-country CCP complies with any requirements imposed by these central banks. The additional requirements could cover risks for liquidity, payment or settlement arrangements in the EU or Member States. In particular, they could concern the availability and specific type of collateral held within a CCP, the level of any haircuts applied to collateral, investment policy or collateral segregation and the availability of liquidity arrangements between central banks involved.
- Written consent by the third-country CCP that ESMA may access any information held by the CCP and may access any of its business premises upon request (this needs to be able to be enforced in the third country, and a legal opinion should be available confirming that this is the case).
- The third-country CCP should have all the necessary procedures and measures to be able to comply with the first and third condition above.
The additional conditions and requirements imposed on Tier 2 CCPs mean that they will effectively be subject to joint supervision by ESMA (with input from the ECB and central banks of issue) and their home country supervisor. The procedures will require coordination between supervisors, and the proposal sets out that ESMA will establish such cooperation arrangements with the relevant third-country competent authorities.
Most importantly, however, ESMA, in agreement with the relevant EU central banks, has the power to determine that Tier 2 CCPs are of ‘specifically substantial systemic significance’ for the EU financial system and recommend to the Commission that the CCP should not be recognised. In practice, this is the third category of CCPs. In this case, third-country CCPs would have to be authorised and established in one of the Member States to be able to provide clearing services to EU clearing members and EU clients.
Supervision of third-country CCPs
ESMA’s powers will also be enhanced for the supervision of CCPs post-recognition. These powers cover information access, general investigations, on-site inspections and enforcement of ongoing compliance. ESMA will also carry out an assessment of the resilience of recognised CCPs to adverse market conditions.
ESMA will require confirmation from each Tier 2 CCP at least on a yearly basis that the requirements for their recognition (see above) continue to be fulfilled. The proposal also provides for ‘review by the Court of Justice of any ESMA decision imposing fines or periodic penalty payments on third-country CCPs’.
ESMA will review at least every two years the recognition of a third-country CCP. In addition, ESMA may also withdraw a recognition decision regarding a third-country CCP if the CCP has committed an infringement. Such infringements relate to capital requirements, organisational requirements, conflicts of interest, operational requirements, transparency and availability of information and obstacles to supervision.
The Commission also suggested that the relevant central banks of issue should be involved in the recognition and supervision of third-country CCPs in relation to financial instruments denominated in Union currencies that are cleared to a significant extent in CCPs located outside the Union. For systemically important CCPs, central banks can impose requirements to address risks arising from liquidity, payment or settlement arrangements in the European Union. This could also extend to specific collateral requirements.
CCP contribution to ESMA budget
EU and third-country CCPs will also be required to pay fees to ESMA for applications for authorisation, applications for recognition and annual fees.
Implications for firms
The proposed rules will have a significant impact on all third-country CCPs, their clearing members and their members’ clients, although the impact clearly rises with a CCP’s systemic importance.
The Commission’s proposal does not require the automatic re-location of third-country CCPs’ euro-clearing activities but has granted ESMA such broad powers in determining which third-country CCPs should be recognised in the EU that it can in effect deny them access to the EU unless they are established in a Member State, provided the criteria set out in the proposal are met.
This opens up the possibility that certain third-country CCPs might not be recognised by ESMA for the purpose of providing their clearing services in the EU under EMIR. In that scenario, EU clearing members and clients would incur significantly higher capital charges and would not be able to comply with the EMIR clearing obligation, if they continued to clear their trades through non-recognised CCPs. To be able to serve their EU clearing members, those third-country CCPs would have to move their clearing activities to the EU through the establishment of a legal entity in a Member State.
ESMA’s enhanced supervision over third country CCPs will require them to liaise regularly with the European regulator and understand its expectations. In particular, Tier 2 CCPs will have to monitor and confirm their compliance with the proposed requirements on a yearly basis.
Overall, ESMA’s broad powers regarding the recognition and supervision of third-country CCPs gives it considerable discretion, which will in turn create uncertainty for CCPs and capital markets participants, at least initially, over how it plans to exercise its authority.
The legislative proposal provides that ESMA should review third-country CCP recognition decisions made before this proposal enters into force. The new provision states that this review shall take place within 12 months from the entry into force of the delegated act specifying the criteria for determining whether a third-country CCP is, or is likely to become, systemically important for the financial stability of the Union or for one or more of its Member States.
The legislative proposal will now be subject to scrutiny by the European Parliament and the Council and is expected to take effect before the end of 2019, but this will clearly depend on the speed of the negotiations. If the Regulation does take effect at the end of 2019 this will be nine months after the UK is due to leave the EU. What happens during this period will depend in part on what, if any, transitional arrangement is agreed.