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According to the latest ISDA study entitled "Central Clearing in the Equity Derivatives Market", European legislators recognised there is a place for customised, non-clearable OTC contracts that enable end-users to manage risk and achieve their investment objectives, and draft regulatory technical standards on risk mitigation techniques for non-cleared OTC derivatives were recently jointly published by ESMA and other supervisory authorities. As well as mandatory reporting and higher capital, these rules will mean non-cleared trades will be subject to margin requirements to mitigate associated risks – although calibration of these requirements will be important to ensure the continued availability of these products, given the absence of cleared substitutes.
As clearing availability develops for sufficiently liquid OTC equity derivatives, however, any clearing obligation decision should consider the unique features of listed and OTC instruments, as well as the specificities of individual products. The cleared futures contracts available on Bclear, for instance, are very different from OTC equity forwards and swaps. Under current rules, they would all be captured under the same bucket, potentially leading to circumstances where a clearing mandate is applied to that entire ‘class’, despite an absence of demand for clearing and no existing clearing service for OTC equity swaps. An overly broad clearing mandate based on underlying, product type or settlement currency – for example, options on European equities – would also be disruptive, potentially capturing contracts for which no clearing service exists.
A granular approach to evaluating whether products should be cleared, including a detailed product taxonomy, a comprehensive review of liquidity and analysis of product standardisation, is vital to the process. This will ensure additional operational hazards are not introduced to the market, and CCPs do not have the opportunity to improperly benefit from a clearing monopoly in certain products.