ESMA released a discussion paper on clearing obligations in the European Market Infrastructure Regulation (EMIR) on Friday, appearing to heed calls for the specificities of covered bonds to be taken into account despite not going for an exemption for the asset class.

ESMA's premises in Paris

The European Covered Bond Council (ECBC) has been calling for OTC derivatives in covered bonds to be exempt from central clearing obligations in EMIR, which would otherwise prevent the derivatives from surviving an issuer default and thereby undermine the essence of a covered bond. (See here for previous coverage.)

The ECBC cited Recital 16 of EMIR, which states that “ESMA should take into account the specific nature of OTC derivative contracts which are concluded with covered bond issuers or with cover pools for covered bonds”.

However, in Friday’s discussion paper the European Securities & Markets Authority (ESMA) said that this recital should not be understood as “calling for an exemption which is not foreseen by the Regulation”. Rather, it should be understood as “encouraging ESMA to take into consideration the nature of the aforementioned contracts”, said the authority.

ESMA goes on to state the importance that derivative contracts not be terminated if an issuer defaults, and that central counterparties (CCPs) are able to differentiate the derivatives of the insolvent issuer from those of the cover pool.

It therefore poses four questions in relation to derivatives in covered bonds:

• Are there other specific features of the contracts concluded with covered bond issuers or with cover pools for covered bonds, to be considered by ESMA in the context of the clearing obligation?
• What would be the legal or technical challenge faced by covered bonds issuers and CCPs, if a clearing obligation was imposed on some of the OTC derivative contracts included in the cover pools of covered bonds?
• Have CCPs developed solutions to be able to differentiate the derivative contracts of the issuer from those of the cover pool?
• Would an appropriate phase-in for these counterparties alleviate these challenges? If so, how?

A covered bond industry spokesperson welcomed the discussion paper as a positive step, saying that although ESMA appears to be refusing to introduce an exemption for covered bonds it is being constructive in showing awareness of the particularities of covered bonds, and that it is “opening the door” for a discussion with the covered bond industry.

The ESMA consultation is open until 12 September and will inform the regulatory technical standards (RTS) that the organisation will draft and submit to the European Commission. The draft RTS will be publicly consulted upon. ESMA said that its procedure to define the classes that should be centrally cleared will only begin when a CCP is authorised under EMIR, or when ESMA has recognised CCP based outside the EU, and that currently no CCPs have yet been authorised under EMIR as the applications are still being assessed.