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The banking turmoil at the end of March prompted you to raise concerns about single-name credit default swap (CDS) markets. What risks do you see?
The events at the end of March confirmed that the single-name CDS market has limited trading activity and low liquidity. This means a small number of trades can have a large price impact, resulting in sharp changes in spreads. Since CDSs are commonly used as an indicator for credit risk, these movements can have consequences for wider investor sentiment and impact share prices and other financial markets.
We are therefore calling for additional transparency, not just in the opaque CDS market, but in other over-the-counter (OTC) derivatives markets too. These markets are global in nature, so we should be pushing to improve transparency and reduce data gaps in Europe, and also aiming for a globally coordinated approach under the aegis of the International Organization of Securities Commissions and the Financial Stability Board.
How does the post-trade transparency regime in the EU compare to the United States and the United Kingdom?
The Markets in Financial Instruments Regulation (MiFIR) introduced trade transparency requirements for OTC derivatives in the EU, including single-name CDSs, but actual transparency regarding trading activity remains very limited. This is for two main reasons. First, most transactions are only published after a significant delay. Second, the scope covered is ambiguous. In practice, only a small number of transactions are subject to the transparency regime at all. This stands in stark contrast to the approach in the United States, where the post-trade transparency regime covers a very broad range of OTC derivatives. Most transactions there are published in close to real time, even if participants are not required to disclose full details of large transactions.
A more ambitious transparency regime as part of the MiFIR review would make markets less opaque and participants better informed, ultimately strengthening the way markets function. It is also important to protect participants from negative market impacts by providing for rules on deferring the publication of trades, calibrated for each class of derivatives. We continue to argue for enhanced transparency in the CDS and other OTC derivatives markets – with appropriate tailoring where necessary at level 2.
One of your key priorities is to strengthen the resilience of central counterparties (CCPs) in the EU. What do you see as the main risks here, and how can these be addressed?
As part of our strategic priorities for 2023-2028 we have reiterated our commitment to helping enhance the stability and effectiveness of EU capital markets. This includes the resilience of the overall market infrastructure, including the CCPs. The ESMA CCP Supervisory Committee conducts an annual risk identification exercise which looks into this area. The Committee is uniquely placed to carry out the exercise, as it is composed of senior representatives of the 12 national competent authorities (NCAs) that supervise EU CCPs, as well as an independent chair and two independent members.
During the market turmoil following the COVID-19 lockdowns and the energy crisis, the surge in initial margins raised questions as to whether CCP margin models may have acted in a procyclical manner. In cooperation with the European System of Central Banks, we have proposed targeted changes to existing regulatory standards to better mitigate the potentially procyclical effects big step-changes in margin can have on clearing members and clients, as well as to prevent liquidity stress spreading to other parts of the financial system.
Another key priority for ESMA is to improve CCP resilience relating to operational risk. Having assessed exposure to critical third-party service providers for the first time as part of the 2022 CCP stress test, we are now focusing on preparations for the implementation of the Digital Operational Resilience Act (DORA).
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