On 10 November 2020, the European Securities and Markets Authority (ESMA) issued a report on post trade risk reduction services (PTRR) under the European Market Infrastructure Regulation (EMIR). In the report, ESMA looks at the different types of PTRR services being offered, their purpose and whether there is a need for the new trades, that these may generate, to be exempted from the clearing obligation, and if such an exemption could lead to the risk of some counterparties circumventing the clearing obligation.
The first part of the report investigates portfolio compression and other available non-price forming post-trade risk reduction services which reduce non-market risks in derivatives portfolios without changing the market risk of the portfolios, such as rebalancing transactions. It explains the purposes and functioning of such PTRR services and the extent to which they mitigate risks, and in particular counterparty credit risk, operational risk and systemic risk. The second part of the report considers a possible exemption to the clearing obligation for trades that directly result from PTRR services. The third part of the report assesses the need for possible conditions that should apply when using the exemption to the clearing obligation for trades that directly result from PTRR services and provides for key features of PTRR services.
ESMA concludes that the benefits of allowing certain PTRR transactions to be exempted from the clearing obligation would reduce risk in the market, allow for legacy trades to be compressed, increase participation in PTRR services of counterparties less interested to participate today (due to complex structures) and overall reduce complexity in the market by using simpler trades for rebalancing. ESMA is of the view that, in the absence of compelling evidence or reasoning to the contrary, those positive effects outweigh, inter alia, the increased operational burden on market participants and regulators and the increase in gross risk in the non-cleared netting sets (in case of portfolio rebalancing). ESMA further notes that the mere function of allowing PTRR transactions to be exempted from the clearing obligation when related to uncleared portfolios of transactions would not reduce the amount of transactions cleared with the central counterparty (CCP). Indeed, currently the risk in portfolios is offset with the use of uncleared instruments. An exemption from the clearing obligation would allow risk to be offset with standardised contracts. Moreover, regarding bilateral outstanding risk, an exemption would allow the booking of one uncleared trade (that would remain in the uncleared portfolio) to offset the bilateral risk between these two counterparties, and in addition, counterparties could book a mirroring cleared trade facing a CCP shifting the overall risk exposures of each counterparty to a CCP. ESMA finally concludes that any such exemption should be limited and subject to certain requirements, to reduce any risk of circumvention of the clearing obligation.
ESMA has submitted the report to the European Commission. The Commission is mandated under EMIR to prepare a report assessing whether any trades that directly result from post-trade risk reduction services should be exempted from the clearing obligation.