The International Swaps and Derivatives Association, Inc. (ISDA), the European Banking Federation (EBF), International Capital Market Association (ICMA) and the International Securities Lending Association (ISLA) have today published a whitepaper on the benefits of post-trade risk reduction services as a crucial risk management tool.
Post-trade risk reduction services like compression and counterparty rebalancing play an increasingly important role in reducing risks in derivatives markets. Compression, for example, results in offsetting trades between multiple parties being torn up, which reduces the size of gross derivatives exposures, in turn reducing systemic risk.
These risk-mitigating benefits are recognized in the European Union (EU) under the revised Markets in Financial Instruments Directive and its associated regulation (MIFID II/MIFIR), which exempt post-trade risk reduction administrative transactions from the trading obligation. There is, however, currently no exemption from the clearing obligation in the EU for these transactions. The failure to recognize these strictly non-trading and market risk neutral administrative transactions within the European Market Infrastructure Regulation (EMIR) limits systemic risk reduction in derivatives markets.
In the paper, ISDA, the EBF, ICMA and ISLA recommend that EMIR be amended as part of the Regulatory Fitness and Performance Program, or REFIT, to exempt transactions resulting from post-trade risk reduction services from the clearing obligation, or to empower the European Securities and Markets Authority to do so.
“Post-trade risk reduction has become an essential risk-management tool for the derivatives market, resulting in hundreds of trillions of euros in derivatives risks being removed. An exemption from the EMIR clearing obligation for transactions resulting from post-trade risk reduction would help further reduce systemic risk,” said Roger Cogan, Head of European Public Policy at ISDA.
“Collateral in the form of margin is an essential risk management tool, but rather than over rely on this mechanism, it makes sense to better facilitate post-trade risk reduction and so reduce aggregate exposure levels,” said ICMA Chief Executive Martin Scheck.
“Recognizing the risk reduction benefits of compression – for example, reducing counterparty risk and therefore systemic risk – is critical when considering amendments to EMIR,” said Mark Hutchings, Chief Operating Officer at ISLA. “For securities lending, post-trade risk reduction like compression will bring with it efficiencies such as less collateral being called, which will ultimately improve collateral liquidity and reduce collateral costs.”
The Associations make the following recommendations on conditions for satisfying any exemption.