Frontloading is a requirement of Europe's incoming swap clearing rules that can force existing trades to be passed to a clearing house, potentially altering their cost structure. "It is beneficial to inform the market as quickly as possible, and we will publish our views within weeks," says Maijoor. "It has not been an easy process as it is a complex issue. The level one text of the European Market Infrastructure Regulation (EMIR) requires frontloading, but we understand this causes uncertainty for market participants."
European legislators had effectively agreed to sidestep the provisions, with ESMA left to draft a rule and send a formal letter outlining the plans to the European Commission. Frontloading requires outstanding swaps to be cleared if they belong to a product class that is later mandated for clearing, which is a problem because cleared and non-cleared swaps have different capital and margining regimes, and could therefore have been mispriced at inception. The requirement only applies to trades that have a certain amount of time left to run – a minimum remaining maturity.
"The parliament agreed with the approach of both ESMA and the commission that frontloading is causing huge problems for market participants, particularly end-users. ESMA will now write a formal letter – to be published on its website – to the commission outlining that it will set the minimum remaining maturity at a sufficiently high level so as not to encapsulate any derivative contracts in the frontloading requirement," said a spokesman for UK MEP Sharon Bowles.
The industry has long argued that frontloading makes it impossible to price trades accurately. For example, if a US dollar swap is backed by euro collateral but is later novated to a clearing house, the trade would then have to be collateralised with dollars – central counterparties (CCPs) insist on the currency of the collateral matching the reference currency of the trade. This means the discount rate used to value the trade would change from the euro overnight index average (Eonia) to the Fed funds rate.
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