ESMA has proposed exempting covered bond derivatives from a central clearing obligation under EMIR if certain conditions are fulfilled, and a market participant said the proposal sends a positive signal.

ESMA's premises in Paris

The European Securities & Markets Authority (ESMA) launched two consultations on Friday, one on interest rate swaps and another on credit default swaps. The former is open until 18 August and the latter until 18 September. The consultations will inform regulatory technical standards (RTS) that ESMA has to develop under the European Markets Infrastructure Regulation (EMIR), which introduces an obligation that certain classes of OTC derivatives be cleared in central clearing houses.

The European Covered Bond Council (ECBC) has been lobbying for covered bond swaps to be exempt from such an obligation, and managed to secure a statement in EMIR, in Recital 16, that ESMA should take into account the specific nature of covered bond OTC derivatives. However, as this did not represent an exemption, the industry has continued to push the case for this, and Boudewijn Dierick, head of covered bond and flow ABS structuring at BNP Paribas, today (Monday) welcomed ESMA’s proposal for dealing with covered bond swaps.

“It looks good,” he said. “Some rewording may be necessary to prevent misunderstanding, but that is a normal part of the process and at least the signal of having an exemption for covered bond swaps is positive.”

Dierick is also chair of the ECBC rating agency approaches working group and in that capacity heads a taskforce set up to deal with EMIR.

ESMA is proposing that covered bond derivatives be exempt from mandatory central clearing as long as certain conditions are met.

In setting out the rationale for its proposal, ESMA cited feedback it received in response to a discussion paper on the central clearing obligation and the specific nature of covered bond derivatives that this feedback emphasised.

The EU authority said that it took the feedback into account and further analysed the specific nature of covered bond derivatives in the context of the clearing obligation, and “has come up with a proposal which leverages on the analysis performed in the context of the current consultation on draft RTS on risk-mitigation techniques for OTC derivative contracts not cleared by a CCP (bilateral margins)”. (See separate coverage on non-centrally cleared derivatives.)

The end result is a proposal that interest rate OTC derivatives used in relation to covered bond programmes not to be required to be centrally cleared if the swap contracts meet six conditions. These are, in ESMA’s words, that:

(a) they are not terminated in case of default of the covered bond issuer;

(b) the counterparty to the contracts, which counterparty is not the cover pool or the covered bond issuer, ranks at least pari passu with the covered bond holders;

(c) they are registered in the cover pool of the covered bond programme in accordance with national covered bond legislation;

(d) they are used only to hedge the interest rate or currency mismatches of the cover pool;

(e) the covered bond programme to which they are associated meets the requirements of Article 129 of Regulation (EU) No 575/2013; and

(f) the covered bond programme to which they are associated is subject to a legal collateralisation requirement of at least 102%.

According to Dierick, the need for some rewording relates to the first two conditions. The second, for example, could be problematic for programmes with swaps initially provided by the originator, which is common practice in Canadian, Australian, Dutch, French, UK and various Nordic programmes, he said.