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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 are subject to very different cost structures, and could therefore have been mispriced at inception. The provision is contained in the European Market Infrastructure Regulation (EMIR), which also contains a way to fix the problem. The requirement only applies to trades that have a certain amount of time left to run – a minimum remaining maturity – and legislators agreed yesterday to set this threshold so high that no trades will be caught, MEPs say, effectively killing off the rule.
"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 their 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 spokesperson for UK MEP Sharon Bowles. After ESMA's letter has been published, the parliament will draft a letter backing that approach, the spokesperson added. ESMA is expected to send its letter to the EC within days.
The Council of the European Union has yet to take a position on the topic, but MEPs do not believe it will object. "The overall conclusion of today's meeting was that ESMA and the EC should start working quickly on a way to minimise the disruption caused by frontloading. And while the council has not come up with a position on this topic yet, ESMA and the EC do not expect it will object to this approach", says Markus Ferber MEP, who added that the parliament would be unlikely to object to ESMA's plans to circumvent frontloading. Industry sources had previously speculated that this would be the outcome of the meeting. The industry has long argued that frontloading makes it impossible to price trades accurately at inception, because cleared and uncleared trades are subject to different funding and capital regimes.
A frontloading window opens once a central counterparty (CCP) has been authorised by its national regulator under EMIR, in turn triggering a requirement for ESMA to decide whether any of the CCP's suite of products are suitable for mandatory clearing – a process that can take up to 16 months. If a mandate is applied, existing trades would be caught if they are above the minimum remaining maturity threshold, which EMIR tells ESMA to set, subject to the EC's approval.
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