First, it is not yet clear whether the clearing requirement detailed in the European Market Infrastructure Regulation, or Emir, published last September, is to be retrospective or not. In other words, if existing trades satisfy the requirement for clearing, then will they be hoovered up within the scope of these regulations or will the clearing requirement apply only to new trades?

Neither is it clear whether foreign exchange-related derivative contracts will be included in the clearing requirement. Marketmakers will argue that the chief risk encountered in the trading of FX derivatives is settlement risk rather than systemic risk, and thus there is no overwhelming need for these contracts to be centrally cleared. But no one knows how this will be determined either. 
Which contracts will be eligible for clearing is also still a matter of debate. European lawmakers will, in the coming weeks, assess which products possess sufficient liquidity for them to be cleared, but the worry is that the net will be cast very wide and relatively illiquid products will be included in this requirement. The extra cost imposed by clearing on the trading of an illiquid instrument could drive it out of existence.

But perhaps most worrying of all is the possibility that, under the markets for financial instruments directive – the second strand to the EU’s regulatory assault on the market in 2011 – European regulators will simply ban products that they don’t like. The MiFID consultation paper includes the proposal to strike down any instrument when no central counterparty is in existence. In theory, the new European Securities and Markets Authority, or ESMA, will assess which products are eligible for clearing and which are not, set a date by which clearing must be enacted and then, if it is not, strike down the offending, uncleared instrument. 

The timetable for the introduction of MiFID is also so aggressive that one is tempted to wonder whether the key precepts have been already decided and the consultation period is simply window dressing. A formal legislative proposal is expected this spring. 

In short, there is much to be concerned about as the OTC derivatives regulatory landscape begins to take shape.

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