10 November 2020 | ESMA70-156-3351
Report to the European Commission
Report on post trade risk reduction services with regards to the clearing
obligation (EMIR Article 85(3a))
1
Table of Contents
1 Executive Summary ........................................................................................................ 3
2 Introduction ..................................................................................................................... 6
3 Background ..................................................................................................................... 7
PART 1 .................................................................................................................................. 8
4 Regulatory framework and characteristics of PTRR services .......................................... 8
4.1 Portfolio compression under EMIR ........................................................................... 8
4.2 The clearing obligation under EMIR ......................................................................... 9
4.3 The trading obligation and portfolio compression under MiFIR ............................... 10
4.4 Reporting of PTRR transactions under EMIR ......................................................... 12
4.5 Exemption from margin requirements for PTRR transactions ................................. 13
4.6 A definition of PTRR services ................................................................................. 13
4.7 Characteristics of PTRR Services .......................................................................... 14
4.8 Administrative transactions .................................................................................... 15
4.9 Introduction to portfolio compression ...................................................................... 15
4.10 Introduction to portfolio rebalancing ....................................................................... 16
4.11 Other PTRR Services ............................................................................................. 18
4.12 Market use of PTRR services today ....................................................................... 18
4.13 PTRR service providers ......................................................................................... 20
5 Noteworthy aspects of PTRR services .......................................................................... 24
5.1 List of possible conditions or requirements established in the consultation paper... 25
5.2 General aspects of the PTRR services and feedback received .............................. 25
5.3 Use of Portfolio Compression ................................................................................. 43
5.4 Use of Portfolio Rebalancing .................................................................................. 45
PART 2 ................................................................................................................................ 47
6 Exemption to the clearing obligation for certain PTRR transactions .............................. 47
6.1 Limiting factors for PTRR services ......................................................................... 48
6.2 PTRR services today ............................................................................................. 48
6.3 Need for an exemption to the clearing obligation for PTRR services ...................... 49
6.4 Respondents critical to the need for an exemption to the clearing obligation .......... 50
6.5 Respondents supporting the need for an exemption to the clearing obligation ....... 51
6.6 Weakening the incentive to clear ............................................................................ 53
6.7 Would an exemption challenge the clearing mandate? .......................................... 55
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6.8 The clearing obligation ........................................................................................... 56
6.9 Optimising collateral use ........................................................................................ 57
6.10 Circumvention of the clearing obligation ................................................................. 60
6.11 Conclusion ............................................................................................................. 61
PART 3 ................................................................................................................................ 65
7 Possible requirements for the provision of PTRR services ............................................ 65
7.1 PTRR service providers acting independently ........................................................ 65
7.2 Build-up of transactions .......................................................................................... 67
8 Summary of key features and requirements .................................................................. 68
8.1 Proposed requirements for the provision of PTRR services to benefit from an
exemption to the clearing obligation .................................................................................. 68
8.2 Conditions to benefit from the clearing exemption on trades resulting from portfolio
compression ..................................................................................................................... 69
8.3 Conditions to benefit from the clearing exemption on trades resulting from portfolio
rebalancing ....................................................................................................................... 69
Annex 1: Portfolio rebalancing .............................................................................................. 71
Annex 2: Cost Benefit Assessment ...................................................................................... 72
8.4 Cost ....................................................................................................................... 72
8.5 Benefits .................................................................................................................. 73
8.6 Liquidity .................................................................................................................. 73
Annex 3: High-level matrix over exemptions for portfolio compression in other jurisdictions . 75
3
1 Executive Summary
Reasons for publication
The European Securities and Markets Authority (ESMA) is mandated to provide a report to
the European Commission, in cooperation with the European Systemic Risk Board (ESRB),
on whether any trades that directly result from post-trade risk reduction services (PTRR
services), including portfolio compression, should be exempted from the clearing obligation
referred to in Article 4(1) of EMIR.
ESMA published a Consultation Paper on 26 March 2020 containing several questions on
PTRR services. The consultation ended on 15 June 2020. ESMA received 13 public
responses and a few confidential responses. This final report to the European Commission
takes into account the feedback provided by the respondents to the consultation. In addition,
ESMA has worked with the ESRB to integrate their input in the final report.
In this report, ESMA is looking into the different types of PTRR services being offered, their
purpose and whether there is a need for the new trades, that these may generate, to be
exempted from the clearing obligation, and if such an exemption could lead to the risk of
some counterparties circumventing the clearing obligation.
Conclusions
The 2008 financial crisis has underlined the importance of central clearing as an effective
risk mitigation tool. Central clearing has an important role to play in reducing systemic risk
in the OTC derivatives markets and remains a cornerstone of safe and transparent markets.
The respondents to the consultation have confirmed that they fundamentally support central
clearing and a majority of financial institutions are now centrally clearing significant shares
of their OTC derivative transaction portfolios, thereby reducing systemic risk in line with the
G20 commitments.
ESMA notes that PTRR services complement the clearing obligation in bringing systemic
risk reduction to the financial market and PTRR transactions are successfully undertaken
today and have reduced a considerable amount of risks in the market. However, the use of
PTRR services today are subject to some noteworthy considerations. PTRR transactions
cannot be clearable if the portfolio they derive from consists of uncleared transactions as it
would detach the replacement or rebalancing trade from the risk it is designed to reduce, for
example in principle legacy trades cannot be compressed today without an exemption. The
market, to some extent, may use other instruments, not subject to the clearing obligation, to
execute PTRR transactions in uncleared portfolios, however such PTRR services become
more complex and the products used are less standardised, to avoid the clearing obligation.
Also, by using more complex transactions PTRR services become less accessible for all
markets participants either due to regulatory concerns or due to less advanced internal
management systems. ESMA therefore notes that without an exemption to the clearing
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obligation PTRR transactions in uncleared portfolios will either not be undertaken today or
would be using PTRR transactions not subject to the clearing obligation.
Hence, if certain compression or rebalancing trades would benefit from an exemption from
the clearing obligation, this would enable market participants to further reduce risk in non-
cleared (and to some extent cleared) portfolios. This reduction in risk on the individual level
would also result in an overall reduction of systemic risk.
ESMA concludes that the benefits of allowing certain PTRR transactions to be exempted
from the clearing obligation would reduce risk in the market, allow for legacy trades to be
compressed, increase participation in PTRR services of counterparties less interested to
participate today (due to complex structures) and overall reduce complexity in the market by
using simpler trades for rebalancing. ESMA is of the view that, in the absence of compelling
evidence or reasoning to the contrary, those positive effects outweigh, inter alia, the
increased operational burden on market participants and regulators and the increase in
gross risk in the non-cleared netting sets (in case of portfolio rebalancing).
ESMA further notes that the mere function of allowing PTRR transactions to be exempted
from the clearing obligation when related to uncleared portfolios of transactions would not
reduce the amount of transactions cleared with the CCP. Indeed, currently the risk in
portfolios is offset with the use of uncleared instruments. An exemption from the clearing
obligation would allow risk to be offset with standardised contracts. Moreover, regarding
bilateral outstanding risk, an exemption would allow the booking of one uncleared trade (that
would remain in the uncleared portfolio) to offset the bilateral risk between these two
counterparties, and in addition, counterparties could book a mirroring cleared trade facing a
CCP shifting the overall risk exposures of each counterparty to a CCP. ESMA finally
concludes that any such exemption should be limited and subject to certain requirements,
to reduce any risk of circumvention of the clearing obligation.
Contents
This report is divided into 3 Parts and 8 Sections. Section 2 provides an introduction to this
consultation paper and section 3 provides a background.
In Part 1, Section 4 covers the types of post trade risk reduction services, including what
they are, how they function, the risks they aim to reduce, why and to what extent market
participants use them and their regulatory framework. Section 5 refers to noteworthy aspects
of PTRR services.
In Part 2, Section 6 assesses how the current clearing obligation may affect those services
and the need to clear or to exempt the new trades that might be generated by PTRR services
(PTRR transactions) from the clearing obligation and assesses the risks with an exemption
from the clearing obligation.
In Part 3, Section 7 considers possible conditions or requirements for the provision of PTRR
services. Section 8 provides key features and proposed requirements for PTRR services.
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Finally, Annex 1 provides a description of rebalancing, Annex 2 provides for a cost and
benefit analysis and Annex 3 presents a high-level matrix over the exemptions for portfolio
compression in other jurisdictions.
With this report ESMA, in cooperation with the ESRB, aims to contribute to the assessment
of the European Commission, in their consideration of post-trade risk reduction services,
and to the extent any exemption should be provided to the clearing obligation.
Next Steps
ESMA has submitted this final report to the European Commission. The European
Commission is mandated under EMIR to prepare a report assessing whether any trades that
directly result from post-trade risk reduction services should be exempted from the clearing
obligation.
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2 Introduction
On 20 May 2019, the European Parliament and the Council adopted Regulation (EU)
2019/834, EMIR Refit, amending Regulation (EU) 648/2012, EMIR, as regards the
clearing obligation, the suspension of the clearing obligation, the reporting requirements,
the risk mitigation techniques for OTC derivatives contracts not cleared by a central
counterparty, the registration and supervision of trade repositories and the requirements
for trade repositories. EMIR Refit was published in the Official Journal on 28 May 2019
1
.
Under Article 85(3a) of EMIR
2
, the European Securities and Markets Authority (ESMA)
is mandated to provide, by 18 May 2020
3
, a report to the European Commission (EC or
Commission), in cooperation with the European Systemic Risk Board (ESRB), on
whether trades that directly result from post-trade risk reduction services, including
portfolio compression (PTRR services) should be exempted from the clearing obligation
referred to in Article 4(1) of EMIR. For ESMA to provide its determination, ESMA shall
investigate PTRR services, explain the purpose and functioning of PTRR services and
the need for the trades directly resulting from PTRR services (PTRR trades or PTRR
transactions) to be exempted from the clearing obligation and, if exempted, whether this
could lead to a circumvention of the clearing obligation.
ESMA published a Consultation Paper on 26 March 2020 containing several questions
on PTRR services. The consultation ended on 15 June 2020. ESMA received 13 public
responses and a few confidential responses. ESMA also consulted the ESMA Securities
and Markets Stakeholders Group. This final report to the Commission takes into account
the feedback provided by the respondents to the consultation.
In addition, ESMA worked with the ESRB in order to integrate their input into the final
report.
Following the submission of the report from ESMA, the EC is mandated to prepare, by
18 December 2020, a report assessing whether any trades that directly result from PTRR
services, should be exempted from the clearing obligation referred to in Article 4(1) of
EMIR. The EC is mandated to submit the report to the European Parliament and to the
Council, together with any appropriate proposals
4
.
Extract from Article 85(3a) of EMIR (as amended by EMIR REFIT).
3a. By 18 May 2020, ESMA shall submit a report to the Commission. That report shall assess: […]
(d) in cooperation with the ESRB, whether any trades that directly result from post-trade risk reduction services,
including portfolio compression, should be exempted from the clearing obligation referred to in Article 4(1); that report
shall:
1
OJ L 141, 28.5.2019, p.42. The text can be found following this link: https://eur-lex.europa.eu/legal-
content/EN/TXT/PDF/?uri=CELEX:32019R0834&from=EN
2
EMIR 648/2012 as amended including by EMIR Refit.
3
Due to the difficult circumstances during which ESMA was developing and published its consultation paper, as a consequence
of the COVID-19 pandemic, a longer consultation period had been provided that initially envisaged.
4
Article 85(3) of EMIR.
7
(i) investigate portfolio compression and other available non-price forming post-trade risk reduction services which
reduce non-market risks in derivatives portfolios without changing the market risk of the portfolios, such as rebalancing
transactions;
(ii) explain the purposes and functioning of such post-trade risk reduction services, the extent to which they mitigate
risk, in particular counterparty credit risk and operational risk, and assess the need to clear such trades or to exempt
them from clearing, in order to manage systemic risk; and
(iii) assess to what extent any exemption from the clearing obligation for such services discourages central clearing
and may lead to counterparties circumventing the clearing obligation;
3 Background
The main objective of the final report is to consider whether a special regime, in the form
of an exemption to the clearing obligation for transactions directly resulting from the use
of PTRR services, should be included under EMIR.
The first part of this report investigates portfolio compression and other available non-
price forming post-trade risk reduction services which reduce non-market risks in
derivatives portfolios without changing the market risk of the portfolios, such as
rebalancing transactions
5
. It aims at explaining the purposes and functioning of such
PTRR services and the extent to which they mitigate risks, and in particular counterparty
credit risk, operational risk and systemic risk.
The second part of this report considers a possible exemption to the clearing obligation
for trades that directly result from PTRR services and provides references to the
responses received under the consultation. It provides for ESMA’s conclusion on an
exemption from the clearing obligation for trades that directly result from PTRR services.
The third part of the final report assesses the need for possible conditions that should
apply when using the exemption to the clearing obligation for trades that directly result
from PTRR services and provides for key features of PTRR services.
The term portfolio compression is used in EMIR Level 2 regulation (Commission
Delegated Act on Risk Mitigation
6
) in relation to the risk mitigation techniques for OTC
derivative contracts not cleared by a CCP and is a defined term in MiFIR
7
8
. The term
5
Rebalancing/optimisation is used in this paper to refer to risk mitigation techniques using offsetting trades to achieve its risk
reduction.
6
Commission Delegated Regulation (EU) No 149/2013 of 19 December 2012 supplementing Regulation (EU) No 648/2012 of
the European Parliament and of the Council with regard to regulatory technical standards on indirect clearing arrangements, the
clearing obligation, the public register, access to a trading venue, non-financial counterparties, and risk mitigation techniques for
OTC derivatives contracts not cleared by a CCP.
7
Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial
instruments and amending Regulation (EU) No 648/2012, OJ L 173, 12.6.2014, p. 84–148.
8
Article 2(47) of MiFIR “‘portfolio compression’ means a risk reduction service in which two or more counterparties wholly or
partially terminate some or all of the derivatives submitted by those counterparties for inclusion in the portfolio compression and
replace the terminated derivatives with another derivative whose combined notional value is less than the combined notional
value of the terminated derivatives.”
8
PTRR services is not a defined term under EMIR or MiFID II
9
/MiFIR but is referred to in
Recital 27 of MiFIR
10
. Although this is not a definition and it is inserted in a recital rather
than in an enacting provision, this seems to indicate that the slightly more limiting
definition is not intending to prevent the use of such other PTRR services beside the
specific regulated portfolio compression. A PTRR transaction could be described as a
non-price forming transaction which reduces non-market risks in derivatives portfolios
without materially affecting or changing the market risk of the portfolios.
This report uses the term PTRR services to refer both to portfolio compression services
as well as to other available non-price forming PTRR services, primarily referring to the
current services of portfolio optimisation services and rebalancing services (risk
rebalancing services).
PART 1
4 Regulatory framework and characteristics of PTRR
services
4.1 Portfolio compression under EMIR
EMIR Article 11(1) requires that counterparties that enter into an OTC derivative contract
not cleared by a CCP must have appropriate procedures and arrangements to measure,
monitor and mitigate operational risk and counterparty credit risk.
Pursuant to EMIR regulatory technical standards (Article 14 of the Delegated Act on Risk
Mitigation), financial counterparties and non-financial counterparties with 500 or more
OTC derivative contracts outstanding with a counterparty which are not centrally cleared,
must have in place procedures to regularly, and at least twice a year, analyse the
possibility to conduct a portfolio compression exercise in order to reduce their
counterparty credit risk. If counterparties do not conduct portfolio compression, they
should be able to provide a reasonable and valid explanation to the relevant competent
authority for concluding that a portfolio compression exercise was not appropriate.
The scope of portfolio compression is further explained in an EMIR Q&A
11
with the
conclusion that portfolio compression does not prevent an offsetting transaction to be
9
Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and
amending Directive 2002/92/EC and Directive 2011/61/EU, OJ L 173, 12.6.2014, p. 349–496.
10
Recital 27 of MiFIR: “The obligation to conclude transactions in derivatives pertaining to a class of derivatives that has been
declared subject to the trading obligation on a regulated market, MTF, OTF or third country trading venue should not apply to
the components of non-price forming post-trade risk reduction services which reduce non-market risks in derivatives portfolios
including existing OTC derivatives portfolios in accordance with Regulation (EU) No 648/2012 without changing the market risk
of the portfolios. In addition, while it is appropriate to make specific provision for portfolio compression, this Regulation is not
intended to prevent the use of other post-trade risk reduction services.”
11
https://www.esma.europa.eu/sites/default/files/library/esma70-1861941480-52_qa_on_emir_implementation.pdf
9
concluded with a counterparty different from the counterparty to the initial transaction.
The Q&A further clarifies some justifications for not undertaking a portfolio compression.
EMIR Article 11(1)
1. Financial counterparties and non-financial counterparties that enter into an OTC derivative contract not cleared by
a CCP, shall ensure, exercising due diligence, that appropriate procedures and arrangements are in place to measure,
monitor and mitigate operational risk and counterparty credit risk, including at least:
(a) the timely confirmation, where available, by electronic means, of the terms of the relevant OTC derivative contract;
(b) formalised processes which are robust, resilient and auditable in order to reconcile portfolios, to manage the
associated risk and to identify disputes between parties early and resolve the, and to monitor the value of outstanding
contracts.
Delegated Regulation 149/2013
Recital
Portfolio compression may also be an efficient tool for risk mitigation purposes depending on circumstances such as
the size of the portfolio with a counterparty, the maturity, purpose and degree of standardisation of OTC derivative
contracts. Financial counterparties and non-financial counterparties that have a portfolio of OTC derivative contracts
not cleared by a CCP above the level determined in this Regulation should have procedures in place in order to analyse
the possibility to use portfolio compression that would allow them to reduce their counterparty credit risk.
Article 14 Portfolio compression
Financial counterparties and non-financial counterparties with 500 or more OTC derivative contracts outstanding with
a counterparty which are not centrally cleared shall have in place procedures to regularly, and at least twice a year,
analyse the possibility to conduct a portfolio compression exercise in order to reduce their counterparty credit risk and
engage in such a portfolio compression exercise.
Financial counterparties and non-financial counterparties shall ensure that they are able to provide a reasonable and
valid explanation to the relevant competent authority for concluding that a portfolio compression exercise is not
appropriate.
OTC Question 10 [last update 4 June 2013]
Article 14 of Regulation (EU) 149/2013: Portfolio Compression
(a) When financial and non-financial counterparties conclude that a portfolio compression exercise is not appropriate,
they need to be able to provide a “reasonable and valid explanation”. What is considered as a “reasonable and
valid explanation”?
(b) Does the requirement on portfolio compression prevent an offsetting transaction to be concluded with a counterparty
different from the counterparty to the initial transaction?
OTC Answer 10
(a) The explanation the counterparty needs to be able to provide to the competent authority when they are requested
to do so should adequately demonstrate that portfolio compression was not appropriate under the prevailing
circumstances. Depending on the circumstances, the justification could include that:
1. the portfolio is purely directional and does not allow any offsetting transactions;
2. multilateral compression services are not available in the relevant markets, for the relevant products, or to the
relevant participants and that compression on a bilateral basis would not be feasible;
3. compression would materially compromise effectiveness of the firm’s internal risk management or accounting
processes.
(b) No. The requirement on portfolio compression does not prevent an offsetting transaction to be concluded with a
counterparty different from the counterparty to the initial transaction.
4.2 The clearing obligation under EMIR
EMIR requires that all OTC derivative contracts subject to mandatory clearing (entered
into or novated on or after the relevant clearing obligation start date) must be cleared in
an authorised or recognised CCP. The clearing obligation covers standardised
transactions that are considered suitable for clearing. Yet, whilst clearing has improved
10
efficiency and reduced counterparty risk and thereby strengthened the stability of the
market in line with the G20 commitments, clearing is not suitable for all types of trades.
For instance, more complex transactions, such as exotic derivatives are not considered
suitable for clearing and would instead be subject to specific risk mitigation requirements,
such as margin requirements and portfolio reconciliation. As a result, financial institutions
continue to have large uncleared portfolios of trades in addition to their cleared portfolios.
When responding to previous ESMA consultations on the clearing obligation, several
respondents mentioned PTRR services and commented on the need to exempt a range
of trades concluded in certain scenarios, including trades generated as part of post-trade
risk reducing initiatives such as multiportfolio compression runs or counterparty risk
rebalancing
12
. However, due to the wording in EMIR, ESMA did not, at that time, have a
mandate to consider conditions leading to a different treatment for such transactions.
4.3 The trading obligation and portfolio compression under MiFIR
MiFIR
13
specifically excludes transactions that derive from portfolio compression from
best execution requirements and from the derivatives trading obligation. The consultation
paper noted the interlinkage with MiFIR. Although the paper did not assess possible
effects of linking an exemption to the clearing obligation with the exemption to the trading
obligation. Hence this final report will not assess in any great details if and how a possible
exemption under EMIR could be affected by the current exemption under MiFIR.
MiFIR
14
and the related delegated regulation with regard to portfolio compression
(Delegated Act on Compression)
15
contain a number of provisions that relate to the
provision of, and participation in, portfolio compression services by investment firms and
market operators.
Article 2(47) of MiFIR “‘portfolio compression’ means a risk reduction service in which two or more counterparties
wholly or partially terminate some or all of the derivatives submitted by those counterparties for inclusion in the portfolio
compression and replace the terminated derivatives with another derivative whose combined notional value is less
than the combined notional value of the terminated derivatives.”
Recital 27 of MiFIR: “The obligation to conclude transactions in derivatives pertaining to a class of derivatives that has
been declared subject to the trading obligation on a regulated market, MTF, OTF or third country trading venue should
not apply to the components of non-price forming post-trade risk reduction services which reduce non-market risks in
derivatives portfolios including existing OTC derivatives portfolios in accordance with Regulation (EU) No 648/2012
without changing the market risk of the portfolios. In addition, while it is appropriate to make specific provision for
portfolio compression, this Regulation is not intended to prevent the use of other post-trade risk reduction services.”
Article 31 Portfolio Compression
1. When providing portfolio compression, investment firms and market operators shall not be subject to the best
execution obligation in Article 27 of Directive 2014/65/EU, the transparency obligations in Articles 8, 10, 18 and 21 of
12
See ESMA Final Report Draft technical standards on the Clearing Obligation – Interest Rate OTC Derivatives, 1 October
2014. https://www.esma.europa.eu/sites/default/files/library/2015/11/esma-2014-1184_final_report_clearing_obligation_irs.pdf
13
https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:02014R0600-20160701
14
Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial
instruments and amending Regulation (EU) No 648/2012 (“MiFIR”).
15
Commission Delegated Regulation (EU) 2017/567 of 18 May 2016 supplementing Regulation (EU) No 600/2014 of the
European Parliament and of the Council with regard to definitions, transparency, portfolio compression and supervisory
measures on product intervention and positions. ESMA provided a technical advice to the EC.
https://www.esma.europa.eu/sites/default/files/library/2015/11/2014-1569_final_report_-
_esmas_technical_advice_to_the_commission_on_mifid_ii_and_mifir.pdf
11
this Regulation and the obligation in Article 1(6) of Directive 2014/65/EU. The termination or replacement of the
component derivatives in the portfolio compression shall not be subject to Article 28 of this Regulation.
2. Investment firms and market operators providing portfolio compression shall make public through an APA the
volumes of transactions subject to portfolio compressions and the time they were concluded within the time limits
specified in Article 10.
3. Investment firms and market operators providing portfolio compressions shall keep complete and accurate records
of all portfolio compressions which they organise or participate in. Those records shall be made available promptly to
the relevant competent authority or ESMA upon request.
4. The Commission may adopt by means of delegated acts in accordance with Article 50, measures specifying the
following:
(a) the elements of portfolio compression,
(b) the information to be published pursuant to paragraph 2,
in such a way as to make use as far as possible of any existing record keeping, reporting or publication requirements.
Based on a technical advice prepared by ESMA
16
, Article 17 of the Delegated Act on
Compression sets out the elements of portfolio compression. It could also be mentioned
that in 2017 ISDA developed a Portfolio Compression Agreement with the objective to
help certain market participants in fulfilling the requirement set in Article 17(2) of the
delegated act
17
.
Commission delegated regulation (EU) 2017/567
Article 17 Elements of Portfolio compression
(Article 31(4) of Regulation (EU) No 600/2014)
1. For the purposes of Article 31(1) of Regulation (EU) No 600/2014, investment firms and market operators providing
portfolio compression shall fulfil the conditions in paragraphs 2 to 6.
2. Investment firms and market operators shall conclude an agreement with the participants to the portfolio
compression providing for the compression process and its legal effects, including identifying the point in time at which
each portfolio compression becomes legally binding.
3. The agreement referred to in paragraph 2 shall include all relevant legal documentation describing how derivatives
submitted for inclusion in the portfolio compression are terminated and how they are replaced by other derivatives.
4. Before each compression process is initiated, investment firms and market operators providing portfolio compression
shall:
(a) require each participant to the portfolio compression to specify the participant's risk tolerance including specifying
a limit for counterparty risk, a limit for market risk and a cash payment tolerance. Investment firms and market operators
shall respect the risk tolerance specified by the participants in the portfolio compression;
(b) link the derivatives submitted for portfolio compression and submit to each participant a portfolio compression
proposal that includes the following information:
(i) the identification of the counterparties affected by the compression,
(ii) the related change to the combined notional value of the derivatives,
(iii) the variation of the combined notional amount compared to the risk tolerance specified.
5. In order to adjust the compression to the risk tolerance set by the participants to the portfolio compression and in
order to maximise the efficiency of the portfolio compression, investment firms and market operators may grant
participants additional time to add derivatives eligible for termination or reduction.
16
https://www.esma.europa.eu/sites/default/files/library/2015/11/2014-1569_final_report_-
_esmas_technical_advice_to_the_commission_on_mifid_ii_and_mifir.pdf
17
https://www.isda.org/2017/11/28/isda-2017-portfolio-compression-agreement/
12
6. Investment firms and market operators shall only perform the portfolio compression once all participants to the
portfolio compression have agreed to the portfolio compression proposal.
4.4 Reporting of PTRR transactions under EMIR
Although ESMA’s mandate to produce this report does not mention the reporting
obligation, it seems important to note that EMIR contains requirements to report all
derivatives entered into under EMIR, including derivatives that would be generated as a
result of running PTRR services on portfolios. The reporting requirements under EMIR
may be found in the RTS on the minimum details of the data to be reported to trade
repositories
18
and the ITS on the format and frequency of trade reports to trade
repositories, where the "compression" flag was populated initially in the Field 11 of the
Table 2 (Common data)
19
but has been moved to Field 16
20
.
Following the amendments to EMIR introduced by Refit, ESMA is in the process of
amending the technical standards on reporting, including the reporting of derivatives that
derive from PTRR services and a consultation paper was published in March
21
. The
responses to the consultation are being assessed and the final report on the technical
standards on reporting will likely be published later this year. The updates are two-fold.
Firstly, to adapt the reporting templates to the increasing number of PTRR services that
are provided. Furthermore, having regard to the fact that the ability to link reports of
different derivatives related to the same business events is currently limited, changes to
require reporting of an identifier univocally linking the derivatives either terminated or
established through the PTRR event, will be a key improvement. Including information
concerning the nature of a business event will be crucial to understand the relationship
between the derivatives resulting from PTRR services not only in the event of
compression, but also where any derivatives are terminated or created due to a PTRR
event. The consultation responses noted that administrative transactions resulting from
PTRR services should be clearly identified and reported as a non-addressable liquidity
(non-price forming) and separate from trading transactions in price and transaction
reporting. Otherwise market participants might be misled into assuming that such PTRR
transactions represented price forming addressable market liquidity.
18
Commission Delegated Regulation (EU) No 148/2013 of 19 December 2012 supplementing Regulation (EU) No 648/2012 of
the European Parliament and of the Council on OTC derivatives, central counterparties and trade repositories with regard to
regulatory technical standards on the minimum details of the data to be reported to trade repositories. https://eur-
lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32013R0148&from=GA
19
Commission Implementing Regulation No 1247/2012 of 19 December 2012 laying down implementing technical standards
with regard to the format and frequency of trade reports to trade repositories.
11 Compression: Y = if the contract results from compression; N= if the contract does not result from compression.
https://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2012:352:0020:0029:EN:PDF
20
Commission Implementing Regulation (EU) 2017/105 of 19 October 2016 amending Implementing Regulation (EU) No
1247/2012 laying down implementing technical standards with regard to the format and frequency of trade reports to trade
repositories according to Regulation (EU) No 648/2012 of the European Parliament and of the Council on OTC derivatives,
central counterparties and trade repositories requires the compression flag to be indicated in Field 16.
https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32017R0105&from=EN
21
Technical standards on reporting, data quality, data access and registration of Trade Repositories under EMIR REFIT
(ESMA74-362-47).
13
4.5 Exemption from margin requirements for PTRR transactions
This report, in line with the consultation paper, does not elaborate on a possible
exemption from the margin requirements for PTRR transactions as this aspect is not
within the mandate provided to ESMA. This also means that where this paper considers
the benefits and risks of an exemption from the clearing obligation for certain trades
generated from PTRR services, it does not affect the application of the risk mitigation
techniques requirements under Article 11 of EMIR, in particular that bilateral margining
would apply to OTC derivatives not cleared by a CCP (provided that the counterparties
and contracts are in scope of the relevant requirements).
4.6 A definition of PTRR services
ESMA raised the question in the consultation what a reasonable definition would be for
PTRR services and received some valuable feedback from respondents. All respondents
(except one) in principle agreed with ESMA’s descriptions of PTRR services.
One respondent provided the following definition of portfolio compression exercises:
“Portfolio compression is a post-trade mechanism that aims to reduce the number of
contracts, the notional amounts of derivatives contracts or some other measure of risk
exposure without materially changing the market risk of the portfolios.
Portfolio compression can be carried out bilaterally (among parties in relation to their
portfolio with each other) or multilaterally among multiple entities in relation to their
portfolios with all the other counterparties taking part in the compression. A
compression proposal must be accepted by all participants to the proposal (the PTRR
service provider is not party to the proposal) or the proposal will be void.”
The same respondent provided the following definition of qualifying portfolio
rebalancing exercises:
“Portfolio rebalancing is a non-continuous risk reduction service that generates a
market risk neutral proposal based on original risk exposures submitted by participants
(two or more) and propose new risk reducing administrative transactions among two or
more participants (the PTRR service provider not being a party to any of those
transactions) which will reduce second order risks for participants.
Portfolio rebalancing exercises are scheduled to take place at a certain time and
proposed new risk reducing administrative transactions must be agreed to by all
participants (or the whole exercise will be void and no new administrative transactions
will be executed). A portfolio rebalancing exercise must reduce the risk it aims to reduce
both across all participants and for each participant individually, based on the input data
provided by all participants.”
ESMA generally agrees with the two definitions provided and have summarised the
characteristics of the services below based on the responses received.
14
Portfolio Rebalancing
Main purpose
Reduce counterparty risk.
Mechanism
Injecting new trades to
reduce the risk of the
portfolio. No trades are
terminated and replaced and
the notional is increased
rather than decreased.
Underlying Portfolio
Uncleared or mixed
portfolios.
Market neutrality
Market neutrality is ensured
by inserting equal amounts
of buy and sell exposures.
4.7 Characteristics of PTRR Services
Before assessing PTRR services, such as compression and rebalancing/optimisation
services in detail, some general features of the services were listed in one consultation
response, and inserted below, in order to try to provide some general characteristics of
qualifying PTRR transactions and exercises.
Market risk neutral: The exercise does not change the directional market risk of the
portfolios concerned, but rather reduces counterparty, operational, basis risk and
systemic risk in respect of existing derivatives transactions. Participants submit their
portfolio and a limited set of tolerances to be respected (e.g. counterparty credit limits
and portfolio risk tolerances).
Second order portfolio risks: PTRR exercises reduce second order risks such as
operational and counterparty risks for existing derivative portfolios, which ultimately
reduces systemic risk. PTRR exercises do not offer a vehicle for taking market
positions – their purpose is risk reduction.
Non-price forming as non-continuous and non-real-time: PTRR exercises’
participants are not able to post bids or offers prices and no price negotiation takes
place. PTRR exercises are “runs” or “cycles” that take place intra-day/over-night
according to pre-published schedules; the service provider’s non-discretionary
methodology determines overall risk reduction opportunities.
All or nothing: PTRR exercises are binding on an “basis across all exercise
participants.
15
4.8 Administrative transactions
The trades resulting from PTRR services do not result from a trading activity and are
referred to as administrative transactions. A significant difference is that, to qualify as
a PTRR transaction and, unlike with trading activity, administrative transactions do not
result from two counterparties meeting in the market with the intention of changing their
respective market positions.
One respondent provided the following illustrative description of the distinction between
trading activity and PTTR’s administrative trades and summarised it as follows.
Trading platforms
PTRR Services
Price
determination
Price forming: bids and offers
submitted
Non-price forming: market risk neutral
within defined thresholds, where
applicable, means transactions can take
place on predetermined prices
Organization
Continuous market
Periodic scheduling of cycles/events
Input
Individual trading interest:
comprising bids or offers
Portfolio level risk positions
Transactions
determination
Trader driven execution
PTRR service provider determined
calculation
Impact on
portfolio’s
market risk
Trading activity: individual
transaction changes portfolio’s
market risk
Risk mitigation: multilateral compound
transaction either does not change
market risk or negligibly changes market
risk of the portfolio within predefined
thresholds
4.9 Introduction to portfolio compression
Portfolio compression is a post-trade mechanism which aims to reduce the number of
contracts, the gross notional or some other measure of risk without materially affecting
the market risk of the portfolio. Although the term “without materially affecting” is not
defined, it implies a restriction on how little the market risk could change following a
compression trade. It is a fundamental component of the symmetric outcome between
counterparties in the compression and relates to the unpredictability for participants
regarding the outcome of the compression when applying tolerances.
Where portfolio compression services were initially only used to terminate trades, either
in full or in part, full market risk neutrality was achieved, as only trades with matching
characteristics and in asset classes with a high degree of standardisation could be
included, as the transactions were not amended but merely the notional was reduced.
16
Hence, portfolio compression created a way to terminate trades without changing the
original risk profile of the participants and compression worked on this basis for many
years. Compression conducted in this way is not so much affected by the clearing
obligation as trades are merely terminated.
Under a compression exercise, where it is not possible to find matching transactions or
no efficient solution can be found by just terminating trades, accepting nearly matching
trades in the compression cycle is essential to achieve the best result. Unlike trade
termination, risk replacement trades are new trades replacing one or more compressed
trades. To undertake such risk replacement trades, the PTRR service provider uses
tolerances with the aim to enhance the efficiency of the compression. How efficient a
compression will be depends on the level of participation and on the tolerances applied
as, in essence, the PTRR service provider uses risk replacement transactions to rebuild
the original risk profile with standardised transactions by replacing old slightly different
transactions with standardised transactions in relation to e.g. maturity dates, rates or
coupons. By undertaking portfolio compression, the counterparties can terminate large
portfolios of transactions without materially changing the original risk profile that those
trades represent. Recently, service providers may also capture counterparty risk under
a compression exercise.
Such replacement trades, even if originated as part of the compression cycle, are subject
to regulatory requirements in force at such point in time, and such trades become subject
to the clearing obligation if applicable.
The definition under MiFIR
22
notes the need to replace the compressed transaction rather
than only cancelling fully or partially trades against each other. Portfolio compression
can therefore be sub-divided into two main types, the riskless compression and the risk
constrained compression. The first type is characterised by exact matching cash-flow
and no market risk change in the portfolio and the second type is characterised by a
minimal and constrained market risk change to the portfolio.
4.10 Introduction to portfolio rebalancing
Beside compression, other types of PTRR services are primarily rebalancing and risk
optimisation services, i.e. services using offsetting transactions to reduce risk in the
portfolio but there may be other established PTRR services either structured similarly or
differently providing reduced risk in designated portfolios.
ESMA understands that rebalancing has been developed to manage risks across cleared
and non-cleared portfolios as today (after the clearing obligation was introduced) parties
may no longer offset their risks in the non-cleared part of the market and the cleared part
of the market i.e. the credit exposure of cleared trades can no longer be netted against
bilateral trades across different asset classes that are not eligible for clearing. This split
22
In the definition of portfolio compression under Article 2(47) of MiFIR portfolio compression means a risk reduction service in
which two or more counterparties wholly or partially terminate some or all of the derivatives submitted by those counterparties
for inclusion in the portfolio compression and replace the terminated derivatives with another derivative whose combined
notional value is less than the combined notional value of the terminated derivatives.
17
of the market creates imbalances within the portfolios and in the end increases IM and
VM requirements. The use of rebalancing transactions aims to reduce those imbalances
by reducing different risks of the portfolios, e.g. interest rate risks (delta risks) across
portfolios with different counterparties and systemic risk. However, to achieve the
envisaged risk reduction, the rebalancing transaction needs to remain in the portfolio it
manages the risk, hence to manage risk in the uncleared portfolio the rebalancing trade
would need to remain in the uncleared portfolio, i.e. it cannot be cleared and novated to
the CCP.
Portfolios of transactions among counterparties consist of many transactions across
different product types which may be highly customized. Any derivative contract with a
future cash-flow has some sort of interest risk built into it (including interest rate products
but also commodity swaps and equity swaps) as future cash flows come with a certain
interest rate risk. Even if the complexity and breadth of transactions in a given portfolio
is extensive, the risk in such portfolio can be expressed using a small number of risk
measures such as delta, vega and gamma. The rebalancing transaction off-sets the
identified risk i.e. the interest rate risk exposure meaning the cost to cover a change of
one basis point to the interest rate of the portfolio at hand.
Rebalancing trades rebalance a certain risk of a portfolio, hence it is important to
consider the portfolios a party has with several counterparties, i.e. Party A’s portfolio with
Party B and Party C are two sub-portfolios in Party A’s total portfolio. The object of a
rebalancing cycle is to change (increase or decrease) the non-market risk in each sub-
portfolio while the overall risk within Party’s A portfolio is reduced. The rebalancing
transaction offsets part of the risk between the parties but rebalancing does not close
out or terminate any trade in the underlying portfolio, which remains unchanged. Instead,
rebalancing adds new transactions that reduces the identified risk from the existing
portfolio of trades. Hence, trades resulting from a rebalancing exercise are based on the
identified risk sensitivities of the portfolio and not the risk sensitivities of each of the
trades, i.e. the underlying trade details. The resulting trades will be different from the
original trades which contribute to the underlying risk exposure.
Rebalancing services are run on a multilateral basis where each participating firm
provides the sensitivities
23
of their portfolio to the PTRR service provider. Typically, only
one product type is used in a rebalancing exercise which will apply identical terms for
buy and sell transactions facing different counterparties to ensure full market risk
neutrality. The resulting trades will be market risk neutral across the exercise for each
participant (please, see Annex 1).
23
For example, a party has several bilateral portfolios with a few counterparties and sensitivity is often measured in relation to a
change, i.e. the EUR 5yr swap rate increases by 1 basis point (“1bp”). The effect of 1bp change results in changes in Party X’s
exposure to a given counterparty and this would be referred to the portfolios’ sensitivity to change.
18
4.11 Other PTRR Services
While most PTRR Services concentrate on the reduction of counterparty credit risk, other
services are emerging on other risk aspects, i.e. legal and contract differences.
One response to the consultation notes that basis risk reduction services would not
naturally fall within PTRR services as this type of PTRR service does not address
bilateral counterparty risk, and as such is not negatively impacted by the current clearing
obligation.
4.12 Market use of PTRR services today
ESMA notes that the recent CCP12 report
24
provides some noteworthy data on the use
of derivatives and compression. It references to the BIS Triennial Survey and notes that
this survey shows substantial growth in trading volumes of Interest Rates Derivatives
(IRDs) between 2016-2019. Average daily volumes (ADV) have increased to $6.5trn, an
increase of 2.4 times since April 2016. The $3.8trn increase in daily volumes is made up
of four components:
a) Cleared volumes have increased by $1.36trn.
b) Intra-group (aka “related party” trading) has increased by $1.15trn per day.
c) Compression volumes increased by $0.74trn.
d) Uncleared volumes have increased by $0.48trn.
Compression and intra-group trades therefore accounted for $1.9trn (49%) of the
increase. This is significant because neither type of trade is risk-generating or market-
facing.
As cleared volumes have continued to grow, and crucially as more participants join the
clearing ecosystem, more risk becomes “compressible”. This is because more
multilateral netting is possible to reduce gross notional exposures closer to the net
notional outstanding. In April 2019, LCH compressed $37trn in notional ($1.66trn ADV).
This has continued to grow, hitting $47trn in a single month in September 2019 ($2.24trn
ADV). The BIS has estimated that compression activity alone accounted for 25%
($0.96trn) of the overall increase in activity reported in the Triennial survey. Cleared
compression volumes are “an order of magnitude greater than uncleared compression”.
The CCP12 report also notes that the gross amount of risk traded has increased
substantially. In the past 3.5 years, the DV01 cleared has increased from around $11bn
per month to nearly $25bn.
The CCP12 report also considers the uncleared market and notes that on interest rate
options “trading has grown from $30bn ADV in Q2-2016 to $55bn ADV in Q2-2019,
according to US SDR data. This increase in volume is significantly below the increases
24
https://ccp12.org/wp-content/uploads/2020/02/Progress_and_Initiatives_in_OTC_Derivatives-A_CCP12_Report.pdf
19
reported by the BIS for the global market. This may be because there is now regular
compression activity in Swaptions. This portfolio maintenance activity can account for
40% of on-SEF Swaption volumes.”
On FX Options trading the CCP12 report notes that “IM optimisation strategies are
popular. Monthly volumes in G3 NDFs, as reported to SDRs, have continued at a pace
of $130bn per month in 2019. Whether these NDFs are being transacted purely as
optimisation trades or at the time of trading the FX Option is difficult to pin down.
Nonetheless, the motivation for them is clear – to bring FX delta into the realm of
uncleared margin rules to compensate against Options delta.”
In relation to legacy trades the CCP12 report note that nearly 80% of outstanding
positions in IRDs are now cleared, which has accelerated in the past twelve months. FX
continues to see a very small uptake of clearing at around 2%. The report also questions
why more of these legacy positions are not being moved to clearing. Understanding the
split of these trades into clearable and non-clearable products would help explain, for
example, why so much of current Credit trades are cleared, whilst legacy risk remains
bilateral.
ESMA notes that there has been an increase in both cleared derivatives and in
compression services, that could be a sign that PTRR services so far has not
cannibalised on the incentives to use CCP clearing.
ESMA encouraged respondents to the consultation to provide data (if possible) to assess
the scope of PTRR services provided and the future of such services with or without an
exemption to the clearing obligation. Some of the data received by ESMA is referenced
below.
It is noted in the responses that PTRR services played a crucial role in reducing post-
trade risks in existing derivatives portfolios, beginning with basis risk reduction in 1999,
portfolio compression in 2002, and counterparty rebalancing services in 2012. It is noted
that generally, the post-crisis regulatory reform agenda has accelerated the markets’
focus on risk reduction, and with it PTRR services. A key benefit to these services is the
reduction of risk in the financial system. Both uncleared and cleared derivatives portfolios
are optimized to minimise the build-up of basis risk, notional amounts, trade count and
counterparty risk, which reduce systemic risk.
TrIOptima provided the following numbers:
• TriOptima’s triReduce service results in counterparties wholly or partially terminating or replacing some
or all the derivatives submitted while leaving net market exposure unchanged. Estimated risk reduction
to date: > €1,500 trillion.
• TriOptima’s triBalance service results in counterparty risk management that rebalances counter-party
risk exposure among multiple CCPs and bilateral relationships while leaving net market exposure
unchanged. Estimated risk reduction to date: > €10.5 billion.
London Stock Exchange provided the following numbers:
20
Between January 2016 to October 2019, LCH has compressed approx. 13 million trades with a total
notional of $2.4 quadrillion
25
. In 2018, SwapClear compressed the equivalent of 72% of the total notional
it cleared. The effects of compression on outstanding notional increased only by $17 trillion while
producing combined reductions in notional of over 1$ quadrillion.
4.13 PTRR service providers
4.13.1 Supervision and authorisation of PTRR service providers and market
participants
In view of the role PTRR service providers are playing and the size of the cycles that are
being run, one consideration is whether PTRR services are also becoming, or already
are, systemically important for the financial stability and should be supervised
accordingly.
A PTRR service provider is not comparable to a CCP as the latter is regulated under
EMIR in terms of risk management and systemic risk prevention. A CCP also assumes
counterparty risks as it becomes the counterparty to the trades, whilst a PTRR service
provider provides a package of transactions to be executed by the counterparties to the
PTRR exercise to achieve the intended risk reduction. Hence, depending on the level of
involvement of the PTRR service provider in the designation, application and execution
of PTRR transactions, different rules and regulations may be relevant to apply to such
PTRR service providers.
Today some PTRR service providers in the Union are authorised under MiFID II as
"Investment firms" meaning "any legal person whose regular occupation or business is
the provision of one or more investment services to third parties and/or the performance
of one or more investment activities on a professional basis
26
". Hence, these PTRR
service providers are authorised for the provision of investment services and there is no
specific authorisation for providing PTRR services.
It is understood from the feedback received that there are still unclear aspects regarding
the status of PTRR service providers and also, to some extent, of market participants
using their services. This report will not address questions raised on MiFID II/MiFIR but
some aspects on MiFIDII and MiFIR are included below to reflect some questions raised
in the feedback to the consultation.
For instance, one response noted that it is not clear whether a market participant offering
offsetting trades into a portfolio compression service or submitting transactions for other
PTRR services would be considered to deal on own account when executing client
orders which would be subject to MiFID II Art. 2(1)(d)(iv).
25
https://www.lch.com/sites/default/files/media/files/Compression%20Watch%20Factsheet_0.pdf - SwapClear Compression
Watch Factsheet
26
Article 4(1) of MiFID II.
21
In addition, as some PTRR service providers offer their services on platforms or through
systems, that technically and legally raise the question if they might be considered MTFs,
regulated markets or direct electronic access to a trading venue; a respondent pointed
out this should be clarified. This uncertainty, according to the feedback received, has an
impact on financial institutions that are not investment firms, and that benefit from a
MiFID II-exemption. The question asked is if the use of certain (or any) PTRR system
could be considered as a membership or participation that would disqualify such entity
from this MiFID II-exemption under Art. 2(1)(d)(ii) of MiFID II, and hence would such
entity then have to apply for authorization under MiFID II.
It is further noted that this lack of legal certainty about the scope of the provisions of
MiFID II and MiFIR with respect to the set-up of various PTRR services and the process
to access PTRR services gets unnecessarily costly and consumes an unreasonable
amount of time, effort and money and still potentially leaves significant legal uncertainty.
4.13.2 New authorisation regime for PTRR service providers
The aim of the report is to investigate PTRR services and if an exemption to the clearing
obligation would be useful or even necessary for PTRR services to be offered effectively
in the market. The oversight and supervision of PTRR service providers is not expressly
mentioned under the mandate to ESMA, however, it is an important aspect in particular
where the intervention of a PTRR service provider becomes compulsory for benefiting
from the clearing exemption.
ESMA in its consultation paper asked whether participants consider that a PTRR service
provider should be specifically licensed or authorised and if so, how and what would be
the benefits of such an authorisation regime.
The feedback received noted that some market participants considered it important to
regulate this service, moreover if an exemption to the clearing obligation requires the
intervention of a service provider in the compression or rebalancing exercise.
The ESRB noted that PTRR service providers should be subject to proportionate
regulatory requirements to ensure that they act independently and according to
established rules and parameters which have been reviewed by a competent authority,
in particular to avoid any use that aims to circumvent the clearing obligation.
In terms of the supervisory surveillance that could be applied to PTRR service providers,
one of the comments received is that PTRR services is an area that is still a relatively
new market and for that reason, the regulatory approach to it should strike the right
balance between the need to preserve financial stability and preserve innovation so that
new technologies can be developed to increase efficiency in the methodologies for risk-
reduction. At the current stage, respondents advocate for a regulatory approach that
encourages prudent innovation and fosters international collaboration among regulators.
It is also highlighted that this is a technology-based business applied to finance, rather
than a financial activity itself and that this is to be taken into account when looking at the
regulatory framework surrounding PTRR service providers’ activities.
According to the feedback received, many consider that the current regulation under
MiFID II which authorises some PTRR service providers as investment firms already
22
contains appropriate requirements regarding governance, independence, product
development and conflicts of interest or under an equivalent third-country regime. In
addition, respondents note the importance of having governance frameworks that ensure
automatic analyses of portfolios and treatment of the outputs or proposals to the point
that there is no or de minimis manual intervention to ensure independence.
Another aspect noted was the algorithms or methodologies used by PTRR service
providers when analysing the portfolios submitted by market participants and how the
provider presents the proposal for trades that will achieve the risk reduction. The
question here was whether these methodologies and algorithms should be subject to a
specific governance regime and if so, on which criteria would this regime be based. A
respondent indicated that the algorithm used has to be subject to supervision and that
this is a crucial part for the commercial success of the business model for providers as
this would also enhance the confidence of market participants in the service. In addition,
it is also mentioned that a robust governance would also help in building trust. However,
another respondent also noted that the current regulatory status is working effectively
and that it is important to preserve the confidentiality of the data managed by service
providers.
A response noted that the independence of service providers can be assessed on an
outcome basis, such as it is envisaged in MiFIR and that the tolerances and parameters
under which the compression or the rebalance exercise is undertaken are not only
checked by the service provider but also by the relevant participants.
Data sensitivity has also been noted in the consultation as PTRR service providers
receive a significant amount of commercially sensitive data on portfolios of market
participants. Hence, service providers’ data management processes must be robust to
ensure the safekeeping of the data.
An aspect raised in the responses, is that PTRR services are conducted globally and
that most participants are large banks located in the EU, the US, Canada, UK and Japan.
In order to achieve the highest levels of efficiency, PTRR exercises benefit from a big
pool of participants, if the population of participants is reduced, less risk is reduced.
Therefore, it is mentioned in the responses that there should be no location requirement
for PTRR service providers, as any location requirement would automatically reduce the
pool of eligible transactions and that having an equivalence regime for third countries is
also crucial.
Bearing in mind PTRR services are performed across global market participants which
are in different jurisdictions, the responses highlighted that policy makers and regulators
should work in a coordinated manner across jurisdictions to facilitate regulatory cohesion
and promote a common understanding and treatment for these services, in particular
regarding exemption from the clearing obligation.
ESMA notes that MiFIR and the Delegated Act on Compression state that investment
firms and market operators providing portfolio compression shall fulfil certain conditions
to ensure the portfolio compression follows certain established rules.
Based on this, ESMA concludes, in line with this mandate and assessment, that ESMA
may consider and propose requirements that should apply to both the service provider
and the participants, to qualify the use or application of the clearing exemption.
23
Regulators would need to be able to access the information kept by the service providers
(record keeping) and participants, including the linkages of trades that need to be
reported under the EMIR reporting framework and also, if needed, to the algorithm used
for the compression or rebalance cycle.
To generally regulate the service providers, i.e. to introduce an authorisation scheme or
authorisation requirements on service providers offering PTRR services generally, would
likely not fall under the mandate, as such an authorisation regime would apply to the
PTRR service provider rather than being linked to the use of the clearing exemption for
trades directly generated by a PTRR exercise. Also, to ensure a level playing field it
would likely be beneficial for the international workstreams to assess the question of if
and how to regulate service providers as a first step.
However, in light of the important role PTRR service providers are playing it may,
depending on the level of involvement of the PTRR service provider in the designation,
application and execution of PTRR transactions, be relevant to consider if such service
providers should be regulated accordingly. This is in ESMA’s view an important aspect,
in particular where the intervention of a PTRR service provider becomes compulsory for
benefiting from the clearing exemption and the amounts compressed or risks rebalanced
continue to increase. ESMA will continue to assess the need to regulate service
providers and stand ready to undertake any further assessments if asked to by the EC
or the legislative parties.
4.13.3 Participation in PTRR services
It is noted in the responses that a full participation of market participants to existing
compression and optimisation exercises is crucial to improve the services.
As noted above, EMIR requires counterparties with 500 or more OTC derivative
contracts outstanding to have in place procedures to analyse the possibility to conduct a
portfolio compression exercise in order to reduce their counterparty credit risk. This
requirement is not a mandatory requirement hence ESMA’s understanding is that
currently the PTRR compression services are dominated by some large derivative
counterparties, primarily banks, where other types of counterparties are less
represented. Adding a variety of counterparties such as the buy side to a greater extent
would be beneficial to the marketplace, which would be covering a wider section of the
overall market for greater overall efficiencies. ESMA agrees with the respondents that a
good representation in PTRR services is fundamental.
ESMA has considered if requiring certain behaviour, such as making it mandatory to use
a service provider in order to take advantage of the clearing exemption would be
advisable., however, this would create a new obligation on the market participants. Also,
to strengthen the current obligation to consider using compression services with an
obligation to use PTRR services or to clearly evidence why such services have not been
used to reduce certain risks of the portfolio, is also creating a new obligation on the
market participants. A draw-back with the use of any obligations established by law is
that there is a risk that where the service providers would be providing their services
voluntarily, such constructions may result in competition, access and pricing issues.
ESMA anticipates that where limiting an exception to the clearing obligation to the
24
situation where the PTRR exercise is managed by a service provider is probably less
likely to create a problem as the use of PTRR services is not strictly mandated and to
use the exemption to the clearing obligation is voluntary.
As noted earlier in the report, accessibility to service providers is very important. Today,
the accessibility has not yet been identified as a potential issue as the PTRR market has
been developed mainly by the major derivatives counterparties, such as banks.
However, given the aim to achieve a wider participation in PTRR services, ESMA would
like to note some aspects.
Any limitations applied by PTRR service providers on accessibility of PTRR services
could result in a reduced ability to use such PTRR services with reduced possibility to
manage relevant risks. Hence any formal requirements on how to access such services
by the service providers should be fair, reasonable and transparent. It is noted that the
first compression may be quite resource intensive, but it is also envisaged that the
following compressions should be easier to manage. In principle, it is very important that
PTRR services are provided in a fair, reasonable and non-discriminatory manner.
Based on above, ESMA would suggest that participation in PTRR services is encouraged
rather than forced at this stage and is hoping that if there is an exemption to the clearing
obligation, market participants would become more inclined to participate in PTRR
exercises. ESMA is considering if other “soft” engagements could be regulated, such as
a requirement for counterparties to take in a quote or test portfolio compression under
the existing requirement for compression under EMIR. However, such requirements are
not pursued at this stage.
5 Noteworthy aspects of PTRR services
As noted above, this report aims to investigate portfolio compression and other available
non-price forming post-trade risk reduction services which reduce non-market risks such
as counterparty, credit, operational and systemic risks in derivatives portfolios without
changing the market risk of the portfolios, such as rebalancing transactions. This report
also aims to explain the purposes and functioning of such post-trade risk reduction
services and if there is merit for an exemption from the clearing obligation, what
conditions should apply.
ESMA has worked with the ESRB to investigate and explain PTRR services, and finally
to assess an exemption from the clearing obligation for PTRR services. The ESRB is
responsible for the macroprudential oversight of the EU financial system and the
prevention and mitigation of systemic risk. In the light of this, their contribution focuses
on the implications of PTRR services in non-centrally cleared OTC markets for
preventing and mitigating systemic risk and promoting the smooth functioning of the
internal market.
25
5.1 List of possible conditions or requirements established in the
consultation paper
ESMA’s consultation paper included a list of possible conditions or requirements applied
in other jurisdictions that provide an exemption to the clearing obligation for PTRR
portfolio compression. The list was non-exhaustive and included the following aspects:
• Only PTRR transactions deriving from multilateral compressions can be exempted,
i.e. more participants than 2 excluding the service provider;
• Only uncleared transactions should be included in the portfolio for compression;
• The compression exercise should result in reduced notional and/or risk;
• The compression exercise should involve the same counterparties as the original
transactions being compressed; and
• The PTRR service provider should be acting independently and PTRR transactions
shall be generated in accordance with a multilateral portfolio compression service
provider’s established rules and parameters for multilateral portfolio compression
exercises.
ESMA asked feedback on whether these requirements were considered suitable in
relation to a potential exemption from the clearing obligation under EMIR for trades
resulting from portfolio compression and if the same conditions could also be applied to
other PTRR services. For that purpose, the Consultation Paper included specific
questions on how different potential requirements could be applied for PTRR services in
the EU.
The feedback received shows support for the application of conditions to benefit from a
clearing exemption, and in some cases ESMA has had to reconsider its initial proposal
to accommodate the views of respondents. Additional conditions where suggested
besides the elements listed by ESMA, such as a condition on periodicity, where a
respondent suggested to include a condition to perform PTRR exercises on cycle basis
with cycles of at least one trading day but not shorter. Other proposals received included
the possibility to require the booking of an equal and opposite trade facing a CCP, after
(or where possible within) the PTRR exercise. Some of those proposed conditions are
analysed in more detail below and the conditions on PTRR services provider providing
PTRR services are considered under Section 8, Summary of key features and
requirements.
However, there are also some respondents that do not agree with the conditions because
they do not support the underlying idea of considering any exemption from the clearing
obligation for trades resulting from PTRR exercises.
5.2 General aspects of the PTRR services and feedback received
5.2.1 Bilateral vs multilateral PTRR services
Portfolio compression can be carried out bilaterally (between two parties in relation to
their portfolio with each other) or multilaterally between multiple entities in relation to their
26
portfolios with all the other counterparties taking part in the compression. Although
bilateral and multilateral compressions are similar in their approach, multilateral
compressions offer increased opportunities for efficiency, as more trades across multiple
parties involved can be offset. It is noted that many jurisdictions only provide for an
exemption to the clearing obligation in relation to multilateral compression, possibly due
to different risk profiles or due to different justifications for an exemption.
Portfolio compression is generally understood as a service provided by a third party (i.e.
not a party to the transactions compressed). It is though important to note that the
process of portfolio compression, and primarily on a bilateral basis, is something that
counterparties to a derivative contract can and currently do themselves.
Multilateral portfolio compression of uncleared transactions is a PTRR service similar to
the multilateral compression undertaken by a CCP but without a central counterparty
such as a CCP at the core of the compression. Portfolio compression is today undertaken
both within CCPs and between counterparties with bilateral portfolios mainly uncleared.
A CCP may participate in multilateral portfolio compression as a participant to the
compression or the parties may after the replacement trade is identified enter into an
equal and opposite trade with a CCP to shift risk to a CCP. A CCP may today also
undertake separate bilateral or multilateral compression exercises within the CCP, with
or without a service provider assisting the compression. One aspect to note is that
compression within a CCP has the benefit of already applying standardised contract
terms hence the need to use rebalancing to harmonise contract terms is less relevant.
In the consultation paper ESMA asked if there is any difference between bilateral and
multilateral portfolio compression that would justify an exemption to the clearing
obligation to apply only for multilateral portfolio compression.
Feedback
A majority of respondents would not see a reason to limit the exemption only to
multilateral compression and a minority of respondents were in favour of limiting it to
multilateral exercises. In addition, two respondents would not consider the exemption
necessary because it could favour a deviation from cleared to uncleared portfolios.
Arguments for a limitation
The ESRB notes that preventing the clearing obligation from being circumvented should
take priority over lifting the clearing obligation to facilitate the use of PTRR services,
hence exemptions from the clearing obligation should be subject to appropriate
conditions to ensure that they are granted only when they bring clear financial stability
benefits while also reducing the risk of misuse. On this basis, the ESRB notes that an
exemption from the clearing obligation, for example, should be limited to multilateral
portfolio compression.
One respondent argued that a multilateral only approach could avoid a loophole to the
clearing obligation as an individual firm could essentially no longer determine itself
whether or not its trades should be cleared and could arguably avoid market participants
structuring transactions specifically to avoid the clearing obligation. It was further noted
by one respondent that the more participants involved, the more the sensitivity threshold
27
of the service would be set to the best common denominator. It was also noted that a
pure bilateral ability to exempt from the clearing obligation would mean that an individual
firm could select which trades to clear or not.
One respondent noted in their consultation response that, theoretically, the smaller the
number of participants the higher the probability that an individual firm could essentially
determine itself whether or not its trades should be cleared. A reservation was also
noted, i.e. if the safeguards (as suggested) would be effective to prevent circumvention
where only two counterparties are involved, notwithstanding the independence of third-
party PTRR service provider.
This is a crucial aspect, if and then how much participants can steer the outcome of the
compression exercise and if this is depending on the number of participants in the
compression.
Arguments against a limitation:
Several respondents supported and would deem it appropriate not to limit an exemption
from the clearing obligation to multilateral compression and to extend it to bilateral
compression as both services will aim to reduce systemic risk. Some market participants
are not convinced that such a limitation would be an effective way to prevent
circumvention (if at all possible) as it is difficult to assess a difference between two and
three participants.
A respondent critical to an exemption mentioned that they do not believe that
differentiating bilateral and multilateral portfolio compression would help limit the risk of
regulatory arbitrage and that having a higher number of participants involved does not in
itself manage the risk of having vanilla trades moved back to the uncleared space as
such risk remains the same if two or more participants are involved.
A PTRR service provider indicated that a bilateral compression can be the result of
bilateral negotiation between the counterparties without the intervention of a PTRR
service provider or by using a PTRR service provider to identify the optimal compression
package for both parties. Respondents point out that an exemption should be granted
where the parties use the services of a PTRR provider to conduct the PTRR exercise
regardless of the number of participants involved in the exercise and where the reduction
proposal presented by such provider is accept in full.
Several respondents supporting an exemption without any distinction for the number of
participants involved instead focus on the use of an independent service provider and on
the counterparties accepting in full the risk reduction proposal by the service provider to
ensure control over the exercise by the provider and to avoid any possible circumvention.
Hence, whether a compression exercise is bilateral, or multilateral, should make no
difference as long as it is performed by an independent third-party provider with
controlled tolerances and non-price forming trades as part of a bona fide compression
exercise.
28
A market association mentions that the process they suggest, introducing an equal and
opposite cleared transactions for each technical risk reducing transaction
27
, would work
for multilateral compressions as well as for bilateral compression. It is noted by one
respondent that a bilateral exercise would theoretically become ‘multilateral’ if it includes
a subsequent trade shifting risk to a CCP. ESMA is of the view that undertaking equal
and opposite trades with a CCP cannot transform the bilateral PTRR exercise into a
multilateral, as the CCP in this scenario did not submit a portfolio for compression.
Considerations
First ESMA has assumed that the compression is undertaken by a service provider, i.e.
there will always be at least two market participants submitting their portfolios and one
service provider applying the algorithm on the submitted portfolios to provide for the
trades to be entered into by the parties to achieve the optimal compression based on the
portfolios and tolerances set. Then ESMA has considered the arguments supporting a
limitation that only PTRR transactions deriving from multilateral compression may benefit
from an exemption, and the arguments against such an exemption.
Today, compression may be undertaken freely as the parties can agree to compress
transactions and such an action would be within their contractual freedom, hence as long
as the replacement transaction is not a transaction subject to the clearing obligation there
would be no reason to restrict the freedom of agreement between the parties. The
aspects to be further assessed are where the replacement transaction is a clearable
transaction and where the parties would apply the clearing exemption (as a result, such
clearable transaction would remain in the bilateral portfolio) and if a potential exemption
is depending on if the compression is undertaken on a bilateral or multilateral basis.
ESMA notes that the most efficient compression is done on a multilateral basis, however
ESMA also notes that this question is mainly limited to the compression of legacy trades
and where such compression could be undertaken on a bilateral basis. Those legacy
transactions, to ESMA’s understanding, are located in different types of counterparties
in the market. The consultation responses noted there is no difference between bilateral
and multilateral portfolio compression. On this aspect ESMA notes that there is an
interest among the participants to also undertake bilateral compression. The question is
how big this group is.
ESMA notes the reservation made by the ESRB, that does not believe that exemptions
should apply to the bilateral space but should be limited to the multilateral space. The
main reason is that whilst the ESRB appreciates the safeguards included in the report,
the ESRB still has reservations that these safeguards would not be effective enough to
prevent circumvention where only two counterparties are involved, notwithstanding the
independence of third-party PTRR service provider as agreements between just two
counterparties are possible, even without the knowledge of the third-party PTRR service
provider.
27
This is further explained in Section 5.2.6.
29
The question is then if the number of participants can have an impact on the possibility
of using the compression service to circumvent the clearing obligation. The answer could
be yes, if you define circumvention as a possibility to effect the outcome of compression
by submitting a limited selection of legacy trades and limit participation to a very few
number of participants, and then compress the legacy trades into an exempted
transaction that would be different than if more transactions were submitted to clearing.
And the answer could be no, if you define circumvention as evading the clearing
obligation either by not submitting transactions that used to be cleared to clearing, or that
cleared trades are withdrawn from the CCP. This is based on ESMA’s understanding
that compression of i.e. legacy trades is not undertaken today, hence the CCP is
unaffected at this level.
ESMA concludes that the participants do control the transactions submitted to
compression but not the outcome of the compression exercise where the compression
is undertaken by an independent service provider. ESMA further concludes that it is
difficult to identify a reason not to allow PTRR transactions directly deriving from bilateral
and multilateral compression services to apply the exemption. ESMA notes that to
provide an exemption, a market need for an exemption, including for bilateral
compression of portfolios, should be evidenced. As no data or numbers were provided
by the market participants this makes it difficult for ESMA to assess the additional risk
reduction that could be achieved if also allowing bilateral compression to use the clearing
exemption.
Can a limitation to only multilateral compression be justified? Multilateral compression
should be defined as involving more than two market participants beside the service
provider. Whilst it is not clear how risks increase going from two to three participants,
ESMA notes that increasing the number of participants would ensure the efficiency of a
compression cycle. ESMA however has not been able to verify that allowing compression
between two parties would be more prone to misuse than if three parties were to be
involved.
Considering the feedback received, ESMA is of the view that the most important aspect
when deciding on an exemption from the clearing obligation is how the compression is
undertaken and the underlying principle of increased efficiency where several parties
participate and the principle underlying PTRR services generally, that they are
undertaken in processes involving several market participants. Based on this, ESMA
does not find the arguments presented overall convincing enough to allow bilateral
compression to benefit from a possible clearing exemption.
5.2.2 Tolerances
To increase the efficiency of PTRR services, tolerances are used. Tolerances are a key
feature for portfolio compression (replacement transactions) but are less relevant for
portfolio rebalancing, as it is further elaborated on under the section on rebalancing.
Under MiFIR, the compression requirements include tolerances such as including a limit
for counterparty risk, a limit for market risk and a cash payment tolerance. Such
tolerances should be specified before the compression and should be respected by the
service provider (i.e. investment firms and market operators under MiFIR).
30
Generally, risk tolerances address how much a participant would accept as a cost in a
change (sensitivity) per basis point of interest rate movement. Tolerances for
compression of interest rate products are expressed in DV01
28
.
Risk tolerances are used to allow the termination or replacement of trades, particularly
in portfolio compression cycles, which do not perfectly match but broadly offset in terms
of risk. This is of particular importance in OTC markets with non-standardised trades, as
without risk tolerances applied trade compression would be reduced to the pure netting
of perfectly offsetting transactions.
Tolerances are also used to manage the risk of using “old” valuations to establish the
replacement trades to ensure the proposals of a PTRR exercise are immune to the
changes over the “acceptance period”. Typically, and as noted above, tolerances are set
to levels so tight that participants are entirely indifferent to the direction the market takes
during the period of the compression exercise. The participants would not know if, due
to the shift in prices, they would see a valuation gain or loss in relation to total
compressed notional. If the PTRR exercise have winners and losers, then only the
winning participants would participate in the proposal.
One respondent describes tolerances in its response: “Without the application of basic
risk tolerances as part of compression or risk rebalancing cycles, such exercises would
either result in strongly impaired results or in uncontrolled risk exposures post-exercise.
Risk tolerances therefore form an essential part of these processes. They are typically
applied to a variety of market risks such as outright/first-order risks to the underlying risk
factor, curve and discounting sensitivities, but equally to counterparty credit risk
measures. Without such tolerances, the risk profile of an existing portfolio of derivative
transactions would not be maintained, nor could counterparty credit risk exposures be
kept within a stable boundary or moved to offsetting counterparty exposures. Some risk
tolerances are driven by the need to accommodate different trade and collateralisation
terms, both between uncleared counterparties and CCPs. […] A prescriptive framework
would not be able to accommodate counterparty-specific risk considerations, as
counterparties may want to accommodate idiosyncratic risk profiles specific to their
institution. An example of firm specific risk considerations are existing counterparty and
market risks over and above the specific compression portfolio: the counterparty credit
risk sensitivity to exchange-rate movements, which will only be partly driven by a subset
of trades included (e.g. in a cross-currency compression cycle).”
There is a trade-off between the efficiency of the compression and the size of the
tolerances of the compression, however both participants and providers have aligned
interest to apply very limited tolerances and importantly the algorithm should not allow
individual risk taking and it should apply small and symmetrical tolerances.
28
Dollar Value of a Basis Point Move (“DV01”). This is a maturity-agnostic measure of risk, converting the notional traded into
the change in valuation of the derivative for each one basis point (0.01%) move in interest rates.
31
ESMA notes that in cases of uncertainty and volatility there is a natural incentive to
reduce the risk tolerances to a minimum in order not to be exposed to an unforeseen risk
change which may adversely affect the participant.
It is noted that there seems to be occasions when small increases in counterparty risk
may occur towards a few participants in order to facilitate greater counterparty risk
reduction against other counterparties but where the overall counterparty risk is reduced.
However, any result of the compression would need to be within the pre-agreed
tolerances.
Feedback
A respondent notes that there is no need for ESMA to define the tolerances as it is in the
interest of both the PTRR service provider and market participants to keep the pre-
defined tolerances small. However, for the case in which ESMA considers that changes
in risk need to be defined, they propose to set tolerances on a product and asset class
basis because what represents a small change in one product may be significant for
another product.
Another respondent argues that market participants do not use PTRR services to take
on new risks and that it is an established standard to use risk-constrained compression
cycles that are non-price forming trades with the standard risk measures around +/-
5,000 USD per basis point of interest rate movement. For this reason, they do not see a
need for limiting the use of a potential exemption to the clearing obligation to risk neutral
PTRR exercises.
Another issue raised in the feedback received is that a regime of tolerances in risk would
allow some flexibility that could be useful for the transition from IBORs to the new risk-
free rates (see Section 5.3.3 on Standardisation and Risk-free Reference Rates).
Another question is if service providers themselves could see benefit in wider tolerances
(as this increases the amount of trades that can be compressed within an exercise). It is
noted in one of the responses that PTRR service providers should not be able to steer
tolerances nor be able to manage the tolerances after being set by the participants.
Considerations
Generally, the tolerances accepted by a participant are measured in how much change
the participant would accept as a cost in a change (sensitivity) per basis point of interest
rate movement. Since the idea behind a compression is not to introduce new risks or to
completely change a portfolio, tolerances are usually set to very tight sensitivity for the
benefit of both counterparties.
It seems that nearly all (if not all) respondents support some moderate tolerances to
facilitate portfolio compression, but there should also be control over any misuse of the
service. One respondent noted that converting IBOR based transactions/portfolios into
portfolios with a higher ratio of RFR based transactions would be near impossible without
using tolerances. However, ESMA notes the tolerances should be applied on each curve
and not on the portfolio of trades being changed from i.e. Eonia to Ester (or any other
32
RFR); the change of curve is a basis trade which is price forming and should not be a
usage of PTRRs.
ESMA also notes that participants are today motivated to put in place a framework for
such tolerances as part of the derivative compression exercises. Noting that risk
tolerances constantly evolve, there is a risk that a prescriptive regulated framework on
tolerances would not be flexible enough to be able to accommodate for market risks and
counterparty-specific risk considerations, as such tolerances of a participant would be
depending on the participants internal rules and models and legal requirements (if any).
For example, some participants may be very sensitive to certain risks such as FX risks
whilst others are less so. Overall, there is little support from respondents to define the
tolerances that can be used as incentives for predefined tolerance levels.
ESMA also notes that tolerances are conceptually within the contractual framework as
they are used by the participants in the compression exercise to mitigate and manage
risks (i.e. counterparty risk). Hence, specifying tolerances could challenge the
contractual freedom as the parties to a contract may amend and terminate contracts as
they wish, and counterparties must be able to manage their risks when participating in a
PTRR exercise. ESMA also notes that entering into an off-setting transaction with a CCP
to shift bilateral risk to CCP risk, would not require specific tolerances.
ESMA considers after taking into account the feedback received, that running a PTRR
exercise should reduce counterparty, operational and systemic risks in respect of
existing derivatives transactions and should not increase exposure on any bilateral
uncleared portfolio by more than the pre-agreed tolerances (market risk). In addition, a
PTRR exercise is not a vehicle for taking market positions or trading transactions.
Therefore, replacement transactions need to be non-price forming, based on prices that
are not updated and without entering into price negotiations.
In rebalancing portfolios, ESMA notes that tolerances do not play a significant role on
the efficiency of the rebalancing outcome as typically, only one product type is used in a
rebalancing exercise which will apply identical terms for buy and sell transactions facing
different counterparties in order to ensure full market risk neutrality.
ESMA considers that tolerances are necessary to achieve efficiency in compression
cycles. ESMA notes that there is no identified reason to limit a possible exemption to the
clearing obligation to only strictly risk neutral compression and tolerances could be used
to increase the efficiency of the compression.
ESMA does not consider it necessary to be prescriptive regarding these parameters as
it is in the interest of counterparties to keep them as tight as possible while allowing room
for efficiency in the compression process. Tolerances are applied symmetrically, and the
compression outcome can go in both directions, i.e. either reducing its exposure or
increasing it without any control about its direction by market participants. ESMA
concludes that defining tolerances would not be useful as the participants are better
placed to decide on the risk-level they are comfortable with.
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5.2.3 Separating cleared and uncleared portfolios and the risk for
circumvention
Some jurisdictions grant an exemption to a trade resulting from compression only when
the original portfolio is exclusively composed of uncleared trades (including legacy
transactions). ESMA asked for feedback regarding whether an exemption for clearing
should only be available for portfolios of uncleared trades in relation to portfolio
compression.
Feedback
A PTRR compression exercise of a cleared portfolio will typically result in new cleared
transactions, for which there would be no need for an exemption from the clearing
obligation because the initial transactions were already in the cleared space and the
PTRR would involve the CCP since the beginning. Therefore, cleared portfolios could
continue to be compressed but would not need a clearing exemption and the relevant
replacement trades could also be cleared without compromising “netting sets”.
Respondents expressed their preference for allowing an exemption for portfolios
including both cleared and uncleared transactions, as it would allow for more flexibility
and could encourage innovation towards new and more efficient PTRR services in the
future.
On the other hand, two respondents acknowledged the possibility of using PTRR
exercises for portfolios containing both cleared and uncleared transactions, but noted
that it is reasonable to only consider an exemption for portfolios with only uncleared
transactions and adds that limiting the exemption only to the uncleared sphere would not
hinder the effectiveness of the PTRR exercise outcome.
Another point raised by respondents, with a preference for limiting the exemption only to
portfolios of uncleared trades, is that this requirement, also applied by other jurisdictions,
would reduce any risk of using PTRR exercises to deviate risk from CCPs to the bilateral
sphere, which undermines the spirit of G-20 reforms.
The sceptics regarding the possibility of granting an exemption from the clearing
obligation observed that limiting PTRR exercises only to uncleared portfolios would only
highlight that G-20 reforms have not achieved the goal of effectively transferring vanilla
risks from the bilateral portfolios to CCPs.
ESMA understands that the position is different for rebalancing as it has been
developed to manage risks across cleared and non-cleared portfolios. The use of
rebalancing transactions aims to reduce those imbalances by reducing different risks of
the portfolios i.e. interest rate risks (delta risks) across portfolios with different
counterparties and systemic risk. However, to achieve the envisaged risk reduction, the
rebalancing transaction would need to be in the portfolio it manages the risk. To manage
risk in an uncleared portfolio the rebalancing trade would need to remain in the uncleared
portfolio, i.e. remain uncleared and not novated to the CCP and similarly to manage risk
in a cleared portfolio the rebalancing trade would need to be cleared to remain in the
cleared portfolio.
34
There is a strong support among respondents in favour of a potential exemption to allow
rebalancing exercises to contain both cleared and uncleared portfolios.
Whilst the ESRB is sceptical of commingling cleared and uncleared trades, the ESRB
also notes that PTRR services reduce several risks and that such benefits also
materialise when these services are applied to mixed portfolios, commingling cleared
and non-centrally cleared trades. Nevertheless, the ESRB notes that there could be
benefits to limit the exemption to uncleared transactions to minimise the risk of it being
used as a technique to circumvent the clearing obligation by creating a loophole to
reverse cleared trades and that the risks of circumvention outweigh the benefits in terms
of improved risk reduction from increased use of PTRR services.
Considerations
a) Cleared and uncleared in compression
Whilst there is support to combine cleared and uncleared portfolios in PTRR services,
there is a concern expressed in the consultation responses that by applying tolerances
theoretically an unlimited combination of transactions could be included in a compression
cycles, without changing the market risk of the portfolio. In other words, the more different
the trades, the higher the tolerance level to facilitate matching.
This could create an issue where compression is undertaken on a combined set of
portfolios, containing both cleared and uncleared trades. A scenario identified, where an
issue could potentially materialise, would be where the CCP participates in a multilateral
portfolio compression as a counterparty to the compression exercise but where the
replacement trades arguably could be a transaction not subject to the clearing obligation,
either because this transaction is not mandated to be cleared or because it is exempted
from clearing (this is not the case today), i.e. compression of swaps and swaptions.
ESMA understands that it is not common today to mix cleared and uncleared portfolios
in a compression exercise, nevertheless this scenario does require some further
considerations.
For example, whilst it seems possible to compress interest rate options alongside interest
rate swaps, FX options alongside FX forwards or swaps alongside swaptions in a
compression this would have to fall withing the applied tolerances. It would be difficult to
compress different types of trades as the tolerances would not accommodate for such a
compression to take place due to the fundamentals of symmetry and uncertainty. Also,
there is no market incentive to widen the tolerances to accommodate compression of
different types of trades. The outcome of a compression exercise depends on factors
outside of the control of the individual participant, such as the trades submitted to the
compression exercise by other participants and the optimisation model applied by the
service provider to reach an efficient compression based on the submitted trades.
It is noted that no participant would know in advance in which direction the tolerances
will be applied and therefore it does not seem likely that the participants could use these
tolerances (even if they were wider) to steer the replacement transactions. No market
participant would enter into a compression with a blank card, i.e. that the risk (and aligned
costs) are unlimited. On the contrary, market participants are careful to control the
outcome of the compression. It is also noted that the PTRR trades should be market risk
35
neutral, i.e. to replace existing transactions with a new replacement transaction would
possibly result in a priceable trade in the market, i.e. where the resulting position,
completely different, would have the same market risk as in a number to the original
compressed transaction, the change from one trade to the other would generate a price
in the market and be price driving and hence not allowed as a PTRR transaction.
All replacement trades should in addition be non-price forming, hence to compress
swaptions with swaps would result in a cost and a new replacement transaction different
from the original transaction, and such transaction would not be considered as non-price
forming trade while this is one of the requirements.
ESMA concludes on the risk of circumvention that compression involving different types
of transactions would firstly have to be within the risk parameters, i.e. the tolerances,
established for the compression, and secondly meet the requirement to be a
“administrative transaction”, i.e. a not price forming transaction. If it is possible to meet
those requirements and still compress transactions in a portfolio consisting of both
cleared and uncleared transactions, ESMA has considered other restrictions that would
apply.
One option to manage the risk of extracting transactions from a CCP would be to restrict
participation of CCPs in multilateral compression exercises, as this would eliminate the
possibility for trades to be “extracted” from a CCP in a compression exercise. However
this could be seen as an unfounded limitation as it would reduce the trades eligible to be
included in the compression and the scope of transactions that are crucial in achieving
an efficient compression.
Another option would be to ensure that no participant in the compression sees an
increase by more than the tolerance of any risk factor in the sum of its bilateral
transactions when a CCP is participating to the exercise and that all PTRR transactions
must not increase by more than the tolerance in the bilateral risk in the portfolio into
which it is booked.
ESMA, in cooperation with the ESRB, concludes that to not allow both cleared and
uncleared portfolios in PTRR compression exercises would be the easiest way to
manage this risk of possible circumvention, and such a restriction would be clear to the
market.
ESMA notes that based on the feedback received in relation to compression, ESMA
would recommend limiting the use of an exemption to the clearing obligation to trades
resulting from a PTRR exercise that only involve a portfolio of uncleared trades. This
would, reading the responses, not impact the effectiveness of such PTRR service in
reducing risks.
b) Cleared and uncleared portfolios in Rebalancing
ESMA understands that today rebalancing exercises include both cleared and uncleared
portfolios of transactions as one drive behind rebalancing is to allow risk to be managed
across portfolios. The underlying portfolios of transactions are not changed, as
rebalancing contains the function of adding transactions to be entered into between the
parties to the exercise to manage and reduce identified risks, such as IR risks.
36
ESMA notes that the ESRB does not share the view that commingling of cleared and
uncleared trades is advisable as the ESRB is of the view that the risks of circumvention
outweigh the benefits in terms of improved risk reduction from increased use of PTRR
services and their argument is that existing trades facing the CCP may be modified or
cancelled. The general risk of circumvention is a concern to ESMA and therefore ESMA
agrees with the ESRB that such risk should be avoided. However, ESMA has not been
able to identify how circumvention would occur in the scenario envisaged of mixing
cleared and uncleared portfolios in a rebalancing exercise as no transactions in the
portfolios are modified or cancelled. In other words, it is not clear to ESMA how such a
technique to circumvent the clearing obligation could be established and to create a
loophole with the aim to reverse cleared trades, as the underlying portfolio of trades
remains unchanged and the rebalancing trades entered into are additional trades to
manage risks. In addition, such rebalancing trades are currently not cleared where
managing risk in an uncleared portfolio (as this would break the netting sets).
Another way of seeing it is that if we allow rebalancing between cleared and uncleared
portfolios, this would allow decomposing (i.e. managing) the risk in a standardised part
that will be cleared and in a non-standardised part that cannot be cleared. So potentially
increasing rather than decreasing the uncleared risk component. While not allowing for
this to happen, would result in all the risk being non-standardised and therefore
uncleared.
An exemption to the clearing obligation would allow the same simple process today used
for FX to be also used for IR (i.e. the same product in the cleared and uncleared netting
sets) and this would allow the market to move exposure from currently bilateral uncleared
netting sets to cleared netting sets.
Based on this reasoning, ESMA considers that to be able to use the same type of
transactions both in the uncleared and the cleared netting sets would limit any risk of
using mis-matching transactions and limit complexity.
ESMA concludes that based on the feedback received on rebalancing, ESMA does not
see a need to apply a similar limitation on rebalancing transactions. PTRR exercises on
rebalancing are often undertaken simultaneously on cleared and uncleared portfolios
and one of the main differences is that the underlying portfolios in rebalancing remains
between the parties and the rebalancing exercises only adds risk-offsetting trades
between the parties in the exercises, hence rebalancing is a risk management tool, and
no transactions are cancelled or adjusted in the underlying portfolio within the
rebalancing exercise.
5.2.4 Reducing market and non-market risk of portfolios
Overall risk reduction by PTRR services
PTRR services should reduce the risk in the overall portfolio and all risk-reducing
transactions must reduce the bilateral risk in the portfolio into which it is booked.
Portfolio compression helps reducing risks such as counterparty, operational and
ultimately systemic risks, by reducing the number of trades, line items and/or notional
exposure between counterparties. In its report “Risk Mitigating Standards for Non-
37
centrally Cleared Derivatives”, IOSCO described the outcome of compression as:
“diminished operational risk for individual market participants which may, in turn, lessen
systemic risk and enhance overall financial market stability
29
”.
Portfolio Rebalancing is based on new trades being entered into to reduce counterparty
risk by reducing a certain risk (i.e. interest rate or currency risks) identified between two
counterparties without changing the trades in the underlying portfolio. This is viewed by
market participants as a way to reduce systemic risk by decreasing the overall exposure
in the market between counterparties.
The general view of the respondents is that operational risk is reduced by the reduction
in exposure and by managing risk through improving the efficiency and transparency of
portfolios under all PTRR services. However, some respondents noted in the responses
that rebalancing exercises would in effect not reduce operational risks as the new trades
entered into between the parties (and allowed with an exemption to remain in the bilateral
sphere, even if subject to a clearing obligation though exempted), would create
operational risks due to the fundamental issue of visibility. Transparency would be lost
as such administrative PTRR transactions would be comingled with bilateral trades not
subject to clearing and increase operational risks as difficult to manage and possible
prone to mistakes in a stressed situation.
MiFIR
Under MiFIR the requirement for portfolio compression is to “replace the terminated
derivatives with another derivative whose combined notional value is less than the
combined notional value of the terminated derivatives.” This “definition” was challenged
already in the consultation response to ESMA’s Technical Advice to the Commission on
MiFID II and MiFIR. Some respondents noted to this consultation that compression is
sometimes performed without a reduction in the notional value of the portfolio but for the
purpose of simplification as for example portfolio compression can be used to aggregate
contracts into fewer contracts without reduction of the notional amount. The purpose of
this exercise could be to standardise the coupons and coupons period, to make them
eligible for clearing or to facilitate the management of the contract. ESMA noted in the
report that the mandate by the Commission granted to ESMA referred explicitly to the
compression as a mean to reduce the notional value of portfolio hence other results that
could be achieved by applying portfolio compression may bring an economic benefit to
the party that will reduce time and cost to manage the contracts resulting from
compression however such compression exercises were not considered.
ESMA would agree with the remarks made at this time and based on above ESMA is
hesitant to this description for PTRR services, ESMA notes that the notional should be
equal or reduced on a portfolio basis for compression exercises, however if equal, other
risks should then be reduced.
29
https://www.iosco.org/library/pubdocs/pdf/IOSCOPD450.pdf
38
For portfolio rebalancing the position is different and this wording would not be a suitable
description of portfolio rebalancing as no trades are terminated and replaced and the
notional is increased rather than decreased as new trades are added though the
rebalancing exercise however the bilateral counterparty risks should be reduced.
Reducing risk under MiFIR
In Recital 27 of MiFIR it is further stated that the obligation to trade derivatives that have
been declared subject to the trading obligation on eligible trading venues should not
apply to the components of non-price forming post-trade risk reduction services which
reduce non-market risks in derivatives portfolios including existing OTC
derivatives portfolios in accordance with Regulation (EU) No 648/2012 without
changing the market risk of the portfolios. ESMA notes that the broad reference to
post-trade risk reduction services was not included under Article 31 as further noted in
Section 3, Background.
One definition of portfolio compression provided in the consultation responses is “a
practice by which market participants transfer their exposure allocation – without
changing it substantially – between existing or new counterparties in order to adjust
exposures between their counterparties, either to reduce risk held against a particular
counterparty or to bring overall exposures down”
30
.
The non-market risk of a portfolio is for example operational, counterparty, and systemic
risk, also referred to as second order risks. The Recital in MiFIR requires for a transaction
to fall under the exemption under MiFIR that the non-market risks should be reduced
overall in the portfolios. The Recital also notes that the market risk should however
not be changed.
Feedback
The question is whether all counterparties whose portfolios in which PTRR transactions
are booked need to demonstrate a reduction in notional amount and/or risk and whether
there should be a requirement for this to be documented by the PTRR service provider
and/or by the participants in the PTRR exercise.
Regarding compression, respondents indicated that the total net notional output after the
exercise should be lower than the net notional input and that ideally, this should be the
case for each and every participant. However, it is also mentioned that in some cases
(described as rare in frequency), a given counterparty could see its notional unchanged
or risk slightly increased while the overall notional in the portfolio is reduced. This would
report a higher benefit for the rest of the participants leaving one party “worse-off”.
Another respondent noted that in order to benefit from a clearing exemption, the PTRR
exercise should comply with three criteria that are interconnected, the first being to
30
ESMA notes the reference to new counterparties and would not agree to allow for an extension of the parties to a portfolio
compression exercise beside the possible involvement of a CCP that may be involved in the process of shifting bilateral risk to
the CCP, but the parties submitting portfolio of trades for compression should remain the same.
39
reduce counterparty credit risk, operational and basis risks of the derivatives portfolio
submitted to the PTRR exercise. The second, to be systemic risk neutral, and third, be
credit risk neutral so the outstanding derivatives are not impacted by the failure of the
provider of the PTRR services.
In order to introduce a requirement to reduce risk in portfolios submitted to a PTRR
exercise, one suggestion from the feedback received points at requiring PTRR services
to reduce the specific risk exposure targeted in the exercise.
(a) In a compression, the service provider should be required to reduce (or leave
unchanged) the outstanding notional, number of trades or any other identified risk in
the portfolio.
(b) In a rebalancing, the service provider should be required to reduce the
outstanding counterparty risk exposure, reducing the initial margin. Another respondent
also indicated that in addition to ESMA’s proposal the total bilateral margin calculated
according to independent models such as the Standard Initial Margin Model (“SIMM”)
should also be included as a metric.
To supervise the risk reductions, a suggestion is for the service providers to do a list of
risk reducing transactions to be applied to the overall risk in the portfolios submitted and
to introduce the requirement to demonstrate that the risk has been reduced accordingly
after the running the PTRR cycle. In addition, as the service providers have no
knowledge of the full portfolios of their clients and of the local clearing obligations, it is in
the interest of the banks involved to show that the risk of their bilateral portfolios has
been reduced and that, if applicable, for all risk reducing or replacement transactions
that are exempt from the clearing mandate, equal and opposite trades on a net basis
have been booked at a CCP to shift residual risk to the CCP. ESMA also notes a
suggestion raised by a respondent that the measures to determine if the risk has been
adequately reduced should be developed by level 2 regulation.
Considerations
The feedback received shows a broad support for including a condition on risk reduction
as a requirement to benefit from a clearing exemption for trades resulting from a PTRR
exercise. However, regarding the metrics to be considered, ESMA is of the view that it
is more effective to focus on the risk exposure than on the notional amounts to determine
when a PTRR service complies with the objective of reducing risk. Therefore, the
condition to be applied to benefit from the exemption could be that the total risk exposure
cannot increase on any bilateral portfolio more than the tolerance agreed with the
participants. Respondents agree with the proposed approach.
Based on this reasoning, ESMA considers that where a compression exercise should
not result in an increased non-market risk overall in the portfolios, some risks may remain
unchanged or increased in the underlying portfolios (but only if the risk overall is not
increased). However, in order not to change the market risks of the portfolios this means
that the compressed transactions must perfectly match. This type of riskless
compression severely limits the scope of the compression otherwise obtainable by risk
constrained compression, i.e. allowing similar (but not identical) transactions to be
40
compressed against each other and replaced by new transactions with reduced non-
market risk.
At the level of individual counterparties, ESMA considers that a PTRR exercise should
not leave a given counterparty with a higher notional (in compression) or a higher risk
exposure (in rebalance) than before the PTRR exercise, even when the overall notional
or risk exposure has been reduced. To this end, ESMA notes that a counterparty could
see its risk unchanged but not increased as a result. This limitation could affect the
efficiency of the exercise but only in few cases as the situation where a counterparty
increases its notional has been reported as rare in frequency. Therefore, ESMA
considers it is in the interest of all participants to be protected against a worse-off
outcome as it would not significantly impact the efficiency of the exercise.
5.2.5 Same Counterparties
One of the current requirements in other jurisdictions is that the PTRR exercise should
involve the same counterparties as the original transactions being compressed. ESMA
wanted to further understand if this practice also applies for the PTRR services offered
today, or possibly to be offered in the future, and any risks with deviating from this
principle. For example, ESMA wanted to know to which extent a CCP can be added to
the PTRR exercise even if it is not a party to one of the original trades; or if other
counterparties could be added to the PTRR exercise to achieve a higher compression
or risk reduction output.
Feedback
The majority of respondents agreed that only the original counterparties participating to
a PTRR exercise can enter into the trades resulting from the PTRR exercise, the
replacement trades or rebalancing trade. A respondent noted that this restriction would
help avoid PTRR service providers from offering what could be seen as a new brokerage
service. Only one respondent did not see a need to impose that limitation.
In a compression, the outstanding risk is reduced by compressing existing transactions
or by introducing new risk reducing transactions. Both parties to a transaction need to
agree to compress the transaction.
In a rebalancing exercise, counterparties to each replacing transaction have to be pre-
defined, for example when counterparties enter into an Interest Rate Swaps to reduce
bilateral Interest Rate DV01 risk leveraging on the exemption from the clearing obligation
for such rebalancing trade. The exposure will only be rebalanced among participants
(outside the CCP) that have actively decided to take part in a rebalancing exercise, which
refers to the fact that the parties to the replacement trades have to be the same ones
that initially submitted their portfolio for rebalancing.
A respondent highlights that given the role of CCPs and the mechanics of central
clearing, the inclusion of a CCP allows for risk to be shifted to a CCP, this is assessed
below under “An “equal and opposite” trade booked facing the CCP.
41
Considerations
ESMA considers that the trades entered into as a result of a PTRR exercise can only be
booked by the counterparties to the original trades in the portfolios submitted to the
PTRR run. This requirement allows for the reduction of risk while preventing the
possibility for market participants to be involved in the compression exercise and benefit
from the exemption for a purpose unrelated to the PTRR exercise.
However, where in the case of compression and rebalancing, after the relevant PTRR
transactions have been entered into, risk is shifted to a CCP (not participating in the
PTRR exercises) this is not adding a new participant to the exercise, as this occurs after
the PTRR compression and rebalancing has been computed.
5.2.6 An “equal and opposite” trade booked facing a CCP
The consultation paper investigated whether participants to a PTRR service also enters
into transactions with a CCP to replace bilateral credit risk with CCP risk and if this is
undertaken today.
Feedback
One of the proposals received from market participants and that seems to have support
from a major group of users of PTRR services is the possibility of entering into equal and
opposite trades with a CCP after a PTRR service, i.e. shifting the bilateral risk of a
rebalancing transaction to a CCP or shifting residual risks in a rebalancing service (after
booking the trades proposed by the service provider) to a CCP. By doing this, the
participants to a PTRR exercise would book the trades proposed to optimise their
portfolios and in a subsequent (in some cases almost simultaneous) also book an exactly
offsetting opposite net trade into their cleared portfolios facing a CCP. This would on one
side reduce the exposure of uncleared portfolios even further and on the other, increase
the proportion cleared portfolios and of risk exposure towards the CCP.
Hence, the proposal received from an association representing market participants
(users of the PTRR exercises) proposes that for each transaction booked by a
counterparty resulting from a PTRR exercise, an equal and opposite transaction on
netted basis should be booked facing the CCP. According to the proposal, the bilateral
transactions would continue existing and both counterparties would book additional
transactions facing the CCP, which would offset the bilateral risk exposure and shift risk
from the bilateral uncleared portfolio to the CCP.
According to the proposal, this is an example of how this mechanism would work:
If as a result of a PTRR exercise, counterparties A and B are proposed to enter in a risk
reducing transaction, for instance an interest rate swap (assuming there is an exemption
from the clearing obligation), and if both counterparties agree to the outcome proposed
by the PTRR service provider, both would book the IRS in their bilateral portfolios. In
addition, they would book a second trade, an equal and opposite risk reducing IRS, for
which they would both face a CCP.
42
In line with the concern described on the unnecessary accumulation of trades (build-up
of transactions), the proposal also considers that to avoid unnecessary booking (and
subsequent compression) of large numbers of offsetting technical risk reducing
transactions, “PTRR service providers should pre-compress CCP-facing transactions
such that the CCP facing risk is booked efficiently, while keeping records of the
corresponding bilateral and cleared IRS to be able to trace compliance with this
condition”.
In their view, when the scope of the clearing obligation expands, this future-proofed
approach automatically expands with it. It would also automatically cover other asset
classes, such as FX and Equities as and when the clearing obligation is extended in
scope to cover those products.
Considerations
ESMA sees value in this proposal as it shifts risk from bilateral portfolios to the CCP, in
line with the policy objectives and G20 measures.
However, this is a transaction outside of the compression exercise and is merely
ensuring the new replacement transaction (where an exempted transaction is used) is
mirrored by an equal and opposite trade facing the CCP to mitigate the fact that the
replacement trade is exempted from clearing but a clearable transaction.
Equally, ESMA further understands that once the rebalancing transactions have been
identified in the exercise, the parties to the exercise may also consider if and how the
net positions of the rebalancing transactions should be followed by offsetting or risk
shifting transactions with a CCP. Hence any net bilateral exposure should be “managed”
by an equal and opposite trade with a CCP and then in effect shifting risk to the CCP by
using, for example, FX/NDFs transactions as such transactions can be used both for
cleared and uncleared netting sets.
The aim would be to merely shift bilateral risk to the CCP. To ensure that this shift of risk
is made in an adequate manner the net position of the new trades in the bilateral portfolio
should be equal to the net position of the new trade(s) facing the CCP.
Those “equal and opposite” trades are additional to the rebalancing exercise and would
hence increase the notional outstanding in the cleared portfolio but would be essential in
achieving the aim of shifting risks to the CCP, where possible, and this is simplified by
allowing cleared PTRR rebalancing transactions both in the uncleared and cleared
portfolios as no basis risk remains between the two.
ESMA supports the principle that the participants of the PTRR exercise should shift
bilateral risk to the CCP after a PTRR exercise (or where relevant within the rebalancing
exercises if a CCP participates directly in the exercise) if the PTRR trades uses the
exemption. Hence, compression and portfolio rebalancing (on a net basis) should be
complemented (where this is not already achieved in the rebalancing exercise) by an
equal and opposite trade with a CCP to shift the risk from the bilateral PTRR transactions
to the CCP. It would be the obligation of the service provider to identify such risk shifting
transactions to the CCP (where possible, i.e. where there is a risk outstanding after the
PTRR service has been completed) and provide them to the participants to be executed
43
as a complementing trade to the PTRR exercise (where such trade is not part of the
rebalancing exercises). ESMA though notes that this condition could have a limited
impact due to the risk neutrality of the rebalancing exercise.
This proposal of “equal and opposite” however raises the issue regarding access to
clearing, ESMA understands that there could be limitations as how to gain access to a
CCP for the participants of the PTRR exercise. This could be the case where the
compression or rebalancing is done on uncleared portfolios as all participants to such
exercise may not have a relationship with a CCP and it may also be the case that the
participants have relationships with different CCPs. ESMA therefore notes some possible
restraints on the accessibility to CCPs by some entities. Based on this, a requirement to
enter into “equal and opposite trades” may be too burdensome and disproportionate to
apply to such entities. In the communication with the market this is not considered a
problem. However, ESMA is cautious if to mandate certain behaviours as such
requirements should not result in an accessibility issue of the PTRR services as this
would be in contrast to the aim of an exemption, which is to facilitate access to PTRR
services for all derivative counterparties in the market. It must be taken into account that
where a participant to the PTRR exercise is not a clearing member of a CCP, it may face
more obstacles accessing the CCP and it may impact its capacity to enter into an “equal
and opposite” trade with the CCP. ESMA acknowledge that where a participant to the
rebalancing exercise is not a clearing member of a CCP, and may have to access the
CCP through a clearing member or through a client providing clearing services, this may
have an impact on the possibility to enter into an “equal and opposite” trade with the
CCP.
Finally, ESMA sees merit in allowing for traceability that links the equal and opposite
cleared transactions to the trades resulting from the PTRR exercise by using the
reporting mechanisms under EMIR.
5.3 Use of Portfolio Compression
To further assess PTRR services, this section aims to explain the purposes and use
of portfolio compression. Multilateral portfolio compression operates both in the
cleared and uncleared space. The main compression is across trades in a cleared
portfolio at a CCP, however, compression is also used in the uncleared space. The focus
of this report is on compression resulting in PTRR transactions subject to the clearing
obligation. In cleared portfolios this is not a concern, however where the underlying
portfolio consists of uncleared trades, such transactions resulting from the PTRR
exercise will be allocated in the cleared portfolio (facing the CCP), rather than to the
bilateral portfolio they originated from. Hence, the compression exercises will today
(without an exemption to the clearing obligation) not be designed to result in a
replacement transaction subject to the clearing obligation where the portfolio of
compressed transactions are uncleared.
5.3.1 Legacy trades
Today, the main reason for exempting certain clearable replacement trades focuses on
compressions of legacy trades (i.e. trades that were entered into before the clearing
44
obligation was put in place) and hence, they were not subject to clearing obligation but if
compressed today, the replacement trades would now be subject to the clearing
obligation. Such replacement trades would lose the legacy derivative status if replaced
through a portfolio compression exercise.
The scope of legacy trades subject to clearing obligation is today relatively small however
CCP 12 concluded in its Report “Progress and initiatives in OTC derivatives” from
February 2020 (the CCP12 Report)
31
that there still remains a stock of legacy trades that
remain uncleared.
Based on this reasoning, ESMA concludes that there are still some types of legacy
transactions that would benefit from compression if an exemption were to be in place.
Some participants have not yet been able to compress such legacy transactions in other
ways, using more complex solutions, which would not trigger the clearing obligation for
these legacy transactions.
5.3.2 New clearing mandates
Another aspect is if new “legacy trades” would be created in the future where new
clearing obligations may be established. It is noted that this aspect could possibly be
managed when the clearing obligation is established but to envisage certain solutions at
this point in time, for example staggered implementations or exemptions for such
replacement trades, is very difficult. Also, such solutions would not likely be within
ESMA’s mandate when expanding the clearing obligation, as per the experience with the
assessments previously done in ESMA reports
32
.
Based on this reasoning, ESMA concludes that the better place to assess a possible
exemption to manage future legacy trades is in this final report.
5.3.3 Standardisation and Risk-Free reference Rates (RFRs)
While most PTRR Services concentrate on the reduction of counterparty credit risk, other
services are emerging on other risk aspects. The use of replacement trades in portfolio
compression could allow the transition of a greater number of existing trades into new
standardised terms. However, while the industry is engaged in a transition from IBORs
to RFRs, one important aspect to note here is that PTRR transactions can only be non-
price forming. Therefore, replacement trades cannot be used as a way to manage basis
risks between different reference rates, since the basis risk have a price in the market.
One respondent noted the reference to IBOR replacement in the following explanatory
text from the recent proposed rulemaking in the US: “One reason that the agencies are
31
https://ccp12.org/wp-content/uploads/2020/02/Progress_and_Initiatives_in_OTC_Derivatives-A_CCP12_Report.pdf
32
See Classes of derivatives subject to the clearing obligation and the respective Final Reports on ESMA’s website:
https://www.esma.europa.eu/regulation/post-trading/otc-derivatives-and-clearing-obligation
45
permitting amendments resulting from compression exercises is to reduce the
operational burden associated with IBOR replacements. While protocols to amend non-
cleared swaps that reference an IBOR or another discontinued rate are in development,
there is a possibility that counterparties may choose to replace portfolios of IBOR-based,
non-cleared swaps with replacement swaps generated through compression
exercises.
33
”
Some respondents noted that an exemption to the clearing obligation would ensure
service providers to assist the market in the benchmark transition and that it is important
to exclude such risk replacement trades from any clearing obligation, as the clearing
obligation may create a disincentive to the use of such trade portfolio compression.
Allowing for legacy trades to be exempted from a future clearing obligation could be
valuable in support of the benchmark transition efforts over the next years but it is unclear
how valuable it will be or if the market will be able to adjust to the new RFRs without
legacy trades remaining.
ESMA provided in December 2019 a statement clarifying that the introduction of fallbacks
to provide clarity in the event that benchmarks used in the relevant contracts change
materially or cease to be provided and how this would impact OTC derivative contracts
in relation to the requirement to exchange collateral
34
. The statement notes that
amendments made to outstanding uncleared OTC derivative contracts (legacy contracts)
for the sole purpose of introducing fall-backs should not create new obligations on these
legacy contracts. In particular, margining requirements should not apply to these legacy
contracts where they were not subject to those requirements before the introduction of
the benchmark’s fall-backs
35
.
Based on this reasoning, ESMA considers that the approach in the ESMA statement
should cover the changes necessary to accommodate for the transition without creating
new trades that could be subject to the clearing obligation. In addition, there is today no
clearing obligation on RFRs and to establish a clearing obligation the requirements on
liquidity and standardisation would need to be met. Hence, the need to provide an
exemption for legacy trades in relation to the transition to RFRs seems to ESMA less
relevant.
5.4 Use of Portfolio Rebalancing
To further assess PTRR services, this section aims to explain the purposes and use
of portfolio rebalancing. As noted above, rebalancing has been developed to manage
risks across cleared and non-cleared portfolios and the use of rebalancing transactions
aims to reduce different risks such as interest rate risks (delta risks) across portfolios
with different counterparties and systemic risk. However to achieve the envisaged risk
33
https://www.occ.treas.gov/news-issuances/federal-register/2019/84fr59970.pdf
34
https://www.esma.europa.eu/sites/default/files/library/esas_2019_19_statement_on_the_introduction_of_fallbacks_in_otc_deri
vative_contracts_to_increase_contract_robustness.pdf
35
There is also a related provision regarding benchmarks, amending EMIR, in the political agreement on the CCP Recovery and
Resolution legislative proposal.
46
reduction, the set-off transaction/rebalancing transaction would need to be in the portfolio
it manages the risk, hence to manage risk in the uncleared portfolio the rebalancing trade
would need to remain in the uncleared portfolio, remain uncleared and not novated to
the CCP.
5.4.1 Instruments to use for rebalancing
To use the right type of instrument to set off an identified risk in the portfolio is crucial as
to use the most optimal type of instruments minimise complexity and maximise the ratio
between risk reduction and added notional. A participant would use, for example, an IRS
to set-off identified interest rate risks in a portfolio and FX NDFs to set-off FX risks
identified in the portfolio.
As noted above, the most common risk is known as “interest rate delta risk” and it arises
whenever you have a future cash flow. This delta or interest rate risk is best hedged with
an interest rate swap hence the market would like to use IRS to manage an interest risk
in an uncleared portfolio and this is today problematic as such a transaction would be
novated to the CCP and not remain in the bilateral sphere off-setting the risk in the
bilateral uncleared portfolio.
Therefore, whilst IRS would be the obvious choice for rebalancing bilateral uncleared IR
delta exposures, they are not available as IRS cannot be inserted into uncleared bilateral
netting sets as those transactions will eventually end up facing the CCP instead. To avoid
using an instrument that is subject to the clearing obligation, other types of instruments
can be used to offset simply interest rate exposures, such as swaptions
36
with the result
that such trade results in increased amount of notional required to reduce risk and also
introduces new risks and complexity. It is noted in the responses that enabling an IRS to
hedge the “delta risk” and for such trade to remain in the same portfolio as it hedges (i.e.
non-cleared) can reduce systemic risk.
There are also more complex risks such as vega, gamma and other curvature risks but
such risk management transactions are often used by more sophisticated parties using
more complex instruments not subject to the clearing obligation.
ESMA notes that whilst it is technically possible to undertake risk management of IR
delta exposures with other rebalancing transactions not subject to the clearing obligation
this generates increased complexity as the process gets more difficult to manage as, for
example, swaptions involve an exercisable option.
As the underlying asset or risk factor fluctuates over time this will require the counterparty
to rebalance on a regular basis adding yet more new trades to the portfolio. Ultimately,
this would potentially lead to a build-up of non-cleared vanilla rebalancing trades. To
mitigate this build-up of transactions, as it might add risk and complexity to the portfolio,
these rebalancing transactions are short dated to limit any build-up of rebalancing
36
Using call-put parity, one can use two European swaptions, a Payer and a Receiver, to replicate a swap.
47
transactions and compressed at a regular basis through the rebalancing exercise. Today
EMIR requires portfolio compression to be undertaken at least twice a year.
5.4.2 The role of a CCP in rebalancing
The role of a CCP participating in a rebalancing exercise can be two-fold. A CCP may
participate in portfolio rebalancing and bring in its portfolio in the rebalancing exercise
and hence to include the CCPs in the rebalancing would result in rebalancing containing
both cleared and uncleared portfolios. A CCP can also assist in the rebalancing exercise
for the sake of allowing transfer of risk from bilateral portfolios to the CCPs, this is further
assessed under section 5.2.6 An “equal and opposite” trade booked facing a CCP.
PART 2
6 Exemption to the clearing obligation for certain PTRR
transactions
After considering what PTRR services are and why they are used in the market, this
section is looking into whether the clearing obligation in some cases might limit the use
of PTRR services. The second part of this final report assesses the need to clear PTRR
transactions or if they should be exempted from clearing, in order to manage systemic
risk.
This section also assesses to what extent any exemption from the clearing obligation for
such services discourages central clearing and may lead to counterparties circumventing
the clearing obligation.
The ESRB noted in their response that they, from a financial stability perspective,
consider exemptions to the clearing obligation should be considered only when they
contribute to reducing systemic risk, subject to appropriate safeguards to avoid the risk
of regulatory arbitrage. In principle, from a financial stability perspective and without
prejudice to the overarching objective of promoting central clearing, exemptions from the
clearing obligation of trades resulting from PTRR services could be allowed where they
demonstrably reduce systemic risk compared to a scenario where such exemptions are
not granted. The ESRB notes the following in their response to the consultation.
“Overall, PTRRS designed to reduce outstanding risk contribute to making the non-
centrally cleared OTC markets safer and more resilient to shocks from the failure of
market participants. The ESRB supports the widespread and frequent use of post trade
risk reduction techniques. By reducing the number of contracts in bilateral OTC
derivatives portfolios and the size of the aggregate gross notional exposures, as well as
by shortening the intermediation chains, these services reduce the operational
complexity of the risk intermediation network by making it more resilient to the possible
defaults of single nodes, reducing interconnectedness and increasing the transparency
of bilateral exposures. The benefits also materialise when these services are applied to
mixed portfolios, commingling cleared and non-centrally cleared trades.”
48
6.1 Limiting factors for PTRR services
As eluded to above, ESMA has identified the following limiting factors for the use of
PTRR services today:
Clearing obligation: It is noted in the responses that the clearing obligation today limits
the use of PTRR services due to the requirement to have the PTRR transactions
located to the cleared netting set with a CCP rather than the bilateral uncleared netting
set with the result that both the replacement transaction and rebalancing transaction
would be detached from the original trades and portfolios.
Participation: Another aspect that effects the efficiency of PTRR services is the level
of participation in the compression or rebalancing service. The greater the participation,
the larger the network of trades and portfolios for compression and rebalances
transactions to be identified. Hence the aspect of participation is important from an
accessibility perspective and it is noted in the responses that the use of complex
transactions (i.e. swaptions) in rebalancing to avoid transactions subject to the clearing
obligation probably results in a lack of participation of less advanced market
participants and this results in less efficiency of such exercises but also a reduced
ability to manage certain risks by such less advanced counterparties.
Amount of trades and the nominal amount: Also, the amount of trades and the
nominal amounts of the trades submitted to a PTRR exercise matters as an efficient
PTRR exercise would be based on a high number of participants as well as every
participant submitting as much transactions as they can within the set boundaries for
the exercise. To reach an increased efficiency each of the participants should submit
all possible trades as if only part of the trading books or portfolios are submitted then
there are limitations effecting the outcome of the exercise as i.e. compression is a cash
flow matter and works its best with a high number of trades submitted to the exercise
and you can match as much as possible.
6.2 PTRR services today
As noted above, EMIR as currently in force, requires compression to be undertaken and
that the trades resulting from portfolio compression are cleared if they fall under the
clearing mandate and does not provide for any kind of exemption from the clearing
obligation for PTRR transactions.
The question raised in the market is how market participants can be fully incentivized to
perform portfolio compression (which is also a requirement under EMIR) without an
exemption to the clearing obligation. It is noted that lack of exemption limits portfolio
compression to operate in the most efficient way and does not appear perfectly aligned
with the approach adopted by MiFIR.
It is also noted that other jurisdictions have exempted from the clearing obligation trades
resulting from portfolio compression activities (provided that specific conditions identified
at regulatory level are fulfilled).
49
It is also noted, and as referred to above, that the problems with treating PTRR
transactions as normal trades and not providing an exemption from the clearing
obligation is not a new issue and that it has been raised in the past
37
and to ESMA in
particular, during the consultation process performed in 2014, where several
respondents explicitly underlined the need to exempt, inter alia, trades generated as part
of post trade risk reducing initiatives such as multi-portfolio compression runs or
counterparty risk rebalancing.
6.3 Need for an exemption to the clearing obligation for PTRR
services
6.3.1 Portfolio compression
Often, compression covers cleared trades only and any replacement trades or new
trades (including partial trades) would also be cleared and the clearing obligation
presents no challenges in this regard.
Most compressions for uncleared portfolios involve non-clearing eligible product types
like cross currency swaps, FX forwards, Interest Rate Swaptions. Today, there is no
clearing obligation for these product types and therefore, no exemption from the clearing
obligation is needed.
Portfolio compression is also carried out through partial or total cancellation or unwinds
of uncleared legacy trades where no new transactions are created, i.e. no replacement
trades and therefore, no exemption from the clearing obligation is needed.
Where replacement trades are used in an uncleared portfolio, they would “break” the
netting sets (if such transactions are subject to the clearing obligation), because
mandatory clearing would allocate such replacement transaction to a cleared netting set
i.e. with the CCP as the counterparty to the trade. This means that the PTRR trade would
not end up replacing the positions it was supposed to within the uncleared portfolio
following the compression. Hence, where replacement trades would require the use of a
cleared product, such as an IRS to replace the portfolio, e.g. for legacy trades, they
cannot be fully undertaken today.
An example of this is noted by one respondent in relation to compression of portfolios
consisting of CDSs on indices undertaken today, i.e. compressions of uncleared trades
which are subject to a clearing obligation. Currently, when operating unwinding proposals
on any remaining legacy uncleared trades, the service does not generate any
replacement trades but only full and partial terminations. The ability to include
replacement trades or new trades to legacy portfolios would enhance the unwinding
efficiency and operational simplicity. A clearing exemption would be beneficial to market
participants.
37
See ESMA Final Report Draft technical standards on the Clearing Obligation – Interest Rate OTC Derivatives, 1 October
2014. https://www.esma.europa.eu/sites/default/files/library/2015/11/esma-2014-1184_final_report_clearing_obligation_irs.pdf
50
6.3.2 Portfolio Rebalancing
For PTRR services such as rebalancing and optimisation services, where the offsetting
trade is not subject to the clearing obligation, for instance if a swaption or a swap in a
currency not in scope of the clearing obligation is used, the trade can remain within the
uncleared portfolio. However, where the PTRR trade is subject to the clearing obligation,
it will be allocated to the cleared portfolio. Therefore, the replacement trade will not be
part of the uncleared portfolio and it will not reduce the risk in the underlying portfolio.
Hence, under the current clearing mandate (not allowing exemptions for portfolio
rebalancing), such rebalancing exercise would not be possible.
To address the issue of the allocation of PTRR transactions to cleared portfolios, i.e.
“broken netting sets” or detached rebalancing transactions, it is argued that the
replacement or rebalancing trades should not be subject to the clearing obligation as the
transaction is only entered into as part of a PTRR exercise, i.e. the PTRR trade would
not have occurred had the PTRR exercise (replacement or rebalancing transactions) not
been undertaken.
Allowing this exemption enables market participants, to reduce the market risk in the
uncleared netting sets, thereby reducing systemic risk.
6.4 Respondents critical to the need for an exemption to the
clearing obligation
A few respondents are critical to a clearing exemption for transactions that are the direct
result of a PTRR services and provides different reasons why an exemption would not
improve the financial stability. Respondents note in their consultation responses that
PTRR services have never been more used than today hence there would be little gains
from such an exemption, however the respondents do not quantify this. Such
respondents do not think that transactions resulting from PTRR services would need to
be exempted to support the growth of those services and instead they see significant
downsides with such an exemption.
It is noted that not granting an exemption was done intentionally to disentangle the highly
standardized trades for central clearing from the more complex exotic trades to be dealt
with under the bilateral margin rules as per the G20 Reforms and that with an exemption
uncleared portfolios would always have a mix of ‘vanilla’ and ‘exotic’ trades going-
forward, and thereby creating mixed portfolios in contradiction to the intentions of the
G20 reforms which sought to shed light on overly complex OTC derivatives markets.
A reference is made, by a respondent, to the fact that a number of jurisdictions have
decided to clarify that legacy trades prior to the clearing obligations are exempt but also
that no major jurisdiction has yet opted for an outright exemption from the clearing
obligation of new trades resulting from PTRR services. Hence the need for an exemption
for legacy trades is challenged and it is noted that all trades concluded prior to the
clearing obligation can already be compressed today and that new trades should not be
used to change the nature of the exposure of portfolios composed of old trades.
51
The need for an exemption is also challenged by noting that delta hedges i.e. rebalancing
transactions can also be done via complex exotic trades, primarily swaptions, rather than
via simple vanilla trades to avoid the clearing obligation. While it is noted that such trades
are indeed riskier than plain vanilla trades, it is noted that they are not riskier than the
transaction they are hedging in the first place. On the same thought it is noted that if
there are financial stability concerns it is recommended that the decision to undertake
such trades are reconsidered and the real issue for participants using a complex trades
to hedge an exotic trade is the overall capital and collateral requirements but it is noted
that this was done intentionally to incentivize the use of less risky vanilla trades.
It is also noted that PTRR services have continued to expand their offerings without
requiring an exemption to the clearing obligation hence such respondents recommend
that ESMA obtain data regarding the current use of PTRR services, including total
number of market participants that are using each such service and total notional
volumes that have been processed by each such service.
6.5 Respondents supporting the need for an exemption to the
clearing obligation
Many respondents generally support a clearing exemption for PTRR transactions to
increase the efficiency of compression and other PTRR services and an exemption
would reduce the risks in non-cleared portfolios (and therefore reduce systemic risk) and
promote regulatory objectives. Multilateral portfolio compression, portfolio rebalancing,
and basis risk reduction services offer the potential for considerable benefits by helping
market participants to reduce risk and manage their derivative portfolios in a responsible
manner.
A majority of the respondents support a clearing exemption for legacy trades that are a
direct result from multilateral compression, many also support an exemption for bilateral
portfolio compression where run by a service provider conducted over a non-cleared
portfolio, where compression is the sole objective of the exercise and where it manages
to reduce overall risk (i.e. reduce notional amounts). The respondents note that they
believe that an exemption is needed in respect of legacy transactions because changes
in market prices can modify the exposure profiles of these legacy portfolios and create
risks. Activities aimed at reducing risk in the market should be welcomed. Such
respondents encourage ESMA to consider significant reductions in bilateral counterparty
risk as well as improved efficiency in the transformation of IBOR trades to RFR-
equivalent that can be derived from the use of PTRR services. The respondents strongly
believe that an exemption from clearing obligation would represent a very strong
incentive for portfolio compression regarding legacy derivatives, which should be
encouraged.
A majority also support an exemption for rebalancing or risk optimisation based PTRR
services. It is noted that one of the largest drivers of uncleared counterparty risk is IR
delta risk. To allow for plain vanilla products to be used to rebalance for example, bilateral
interest rate DV01 risk among market participants in a portfolio would result in a relatively
simple bilateral derivatives product, such as IRS could be used. Plain vanilla transactions
can, at times, be replaced by non-plain vanilla transactions in PTRR services, although
52
this may result in new risks being added to a portfolio that must subsequently be
managed.
The respondents note that existing PTRR services rely on products that fall outside the
clearing obligation which, by their nature, are often more complex and this naturally limits
the usability of these services to those firms with less ability or mandate to manage such
products. For example, bilateral interest rate delta reduction can be achieved by using
swaptions although this introduces additional risk at expiry and requires up to twice the
notional that plain vanilla swaps would require. These workarounds for avoiding the
clearing obligation hence require the use of complex administrative transactions that
introduce new risks to be managed and represent a more onerous approach and
additional operational risk implications for the participants and service provider.
The respondents further highlight that the use of swaptions is complex and may hinder
certain participants that would otherwise be inclined to take part in a PTRR exercise. It
is important from the perspective of optimal risk management and financial stability that
market participants are able to achieve portfolio risk reduction without having to resort to
complex workaround solutions that not all holders of risk can or want to implement. It is
noted that to be able to use a simple product, such as an IRS trade that is specifically
intended to hedge risk, rather than using other more complex instruments, like
swaptions, would greatly simplify the process.
Therefore, several respondents stress that the accessibility should not be ignored, as
today participation in the compression and rebalancing exercises are mainly larger
market entities and less advanced participants are disincentivised from participating due
to the use of complex strategies for uncleared risk rebalancing services. To increase the
industry participation, it is essential to allow PTRR services to be as efficient as possible
in counterparty credit risk management via PTRR exercises. Hence, to allow simple
products to be used for rebalancing would, at a minimum, remove barriers of entry for
new participants and this would improve the efficiency for many portfolio rebalancing
exercises by allowing less sophisticated firms to leverage these services. The best
outcome is to facilitate the proper use of PTRR services by providing an exemption from
the clearing obligation.
Based on that, respondents believe that an exemption from the clearing obligation for
transactions directly resulting from PTRR services would increase the use of PTRR
services for the following reasons:
(i) less sophisticated firms might not be able to participate today to price and risk
manage swaptions etc., but would be comfortable with using plain vanilla
products, such as an IRS, hence the use of more vanilla products will make the
compression and rebalancing more straightforward and therefore easier to
manage for firms;
(ii) it would mitigate the concern in the market that complex products like swaptions
are used for PTRR purposes just in order to avoid the clearing obligation;
(iii) ability to streamline the portfolios by eliminating line items and thereby making
trading books smaller, cleaner and far more efficient from a margin and capital
requirements standpoint to the benefit of other economic activities that can be
undertaken by the same market participants;
53
(iv) reduction in operational risk due to the number of trades is reduced in
compression hence the potential operational risk linked to dealing with multiple
transactions is reduced and equally a reduction in operational risks will occur if
less complex type of trades could be used to rebalance portfolios;
(v) reduced counterparty risk, as trades across multiple counterparties could be
offset reducing the open risk in bilateral relationships; and
(vi) enhanced financial stability as authorities should also consider the potential
effects on financial stability due to the impact on default management, as a
result of potentially smaller and ‘cleaner’ portfolios.
An exemption would enable parties to better manage their credit risk profiles while
enabling a greater proportion of risk to be moved to face a CCP and therefore reduce
systemic risk. To allow the parties to book trades into their non-cleared portfolios with an
exact offsetting opposite trade in their cleared portfolio, rather than using different types
of transactions as is the case today, would be supported.
A respondent noted that a potential exemption from the clearing obligation under EMIR
subject to conditions should be aligned with a potential exemption from the trading
obligation under MIFID. Introducing a clearing exemption for these transactions under
EMIR would align EMIR and MIFID II/MIFIR as Article 31 MiFIR states, inter alia, that the
termination or replacement of the component derivatives in the portfolio compression are
exempted from the derivatives trading obligation under Article 28 MiFIR even if these
derivatives belong to a class designated as subject to the trading obligation. To align
EMIR with MiFIR would according to some market representatives also be consistent
with the objective to align as much as possible the MiFIR and the EMIR regime (ESMA
“Final Report-Alignment of MiFIR with the changes introduced by EMIR Refit” February
2020
38
).
6.6 Weakening the incentive to clear
There are strong incentives to clear transactions including margin requirements and
capital requirements for non-centrally cleared transactions and the CCP12 Report notes
that uncleared margin requirements have motivated increased activity in cleared
markets. The G20’s commitments following the financial crisis are designed to ensure
that the risks of bilateral derivatives portfolios are appropriately managed and
collateralised. The IOSCO report on “Incentives to centrally clear over-the-counter (OTC)
derivatives”
39
clearly demonstrates the importance of uncleared initial margin
requirements in assessing incentives to centrally clear. Dealers and client clearing
service providers identified the uncleared margin requirements as incentivizing central
clearing more than any other regulatory reform.
40
38
https://www.esma.europa.eu/sites/default/files/library/esma70-156-
2076_emir_final_report_on_alignment_clearing_and_trading_obligations.pdf
39
https://www.fsb.org/wp-content/uploads/R191118-1-1.pdf.
40
IOSCO Report at Figure D.1 (page 26).
54
One of the arguments made against the need to exempt trades resulting from PTRR
services is that by exempting, for example, the delta hedge vanilla swap trade from the
clearing obligation this would be weakening the clearing obligation itself (as de facto less
exposure is covered by central clearing), but also the incentives to clear (as there will
now be a cheaper option to hedge the portfolio or swaption in the bilateral space). ESMA
considers this thinking to be incomplete, as the above mentioned ‘delta hedge vanilla
swap trade’, without an exemption, would be entered into using an uncleared PTRR
transaction and the transaction would never be cleared.
A respondent notes that the PTRR exercises are fundamentally designed to reduce the
costs associated with trading uncleared OTC derivatives, both from a margin and capital
perspective. To the extent the costs associated with trading uncleared OTC derivatives
are materially reduced and market participants are able to enter into transactions that
would normally be subject to the clearing obligation on an uncleared basis, then in many
cases it may become more cost effective to transact on an uncleared basis, undermining
the G-20 post-crisis reforms.
Statements like those are challenged by several other respondents stating that an
exemption from the clearing obligation would not be an incentive not to clear transactions
directly resulting from a PTRR services that technically are covered by the clearing
obligation, because a PTRR service is a separate post-trade activity and they note that
there must be a clear separation between trading and PTRR services. It is noted that the
characteristics of PTRR services are very distinct, and they should rather be considered
as tools that improve the accuracy of the counterparty risk management, and the
collateral liquidity management.
In addition, it is mentioned in responses that PTRR exercises that would create a trade
subject to clearing will not be entered into today as such trade would not be allocated to
the right netting set, i.e. would be allocated to the cleared netting set rather than the
uncleared and would not meet the requirement of reduced risk as the replacement trade
or rebalancing trade would be detached from the original portfolio of trades subject to
the PTRR service.
It is also noted that market participants clear those trades that can be cleared because
of existing incentives and the willingness to clear is more driven by the benefits of
clearing like multilateral netting, operational efficiency and reduced risk than by the cost
of un-cleared portfolios.
Some respondents refer back to the aim of PTRR services as a tool and that an
exemption could rather be seen as an incentive for participants to move some of the
bilateral risk to a more strictly regulated and controlled environment while at the same
time benefit from improved resource optimisation and from a reduction in operational
risk. Consequentially, improved default management processes and smaller/’cleaner’
portfolios would strengthen financial stability which has always been the core objective
of EMIR.
PTRR transactions resulting from PTRR services are risk reducing tools and not trading
activities as they require the existence of a portfolio of transactions traded between the
parties to be able to manage the risk identified in such portfolio. ESMA does not see how
an exemption for PTRR transactions resulting from a PTRR exercise would be
55
“emptying” trades from a CCP because today PTRR trades uses uncleared trades to
ensure such transactions remain bilateral to avoid breaking the netting sets or detach
the PTRR transaction from the original trades.
Following from this reasoning, ESMA has not seen any evidence that an exemption from
the clearing obligation for PTRR trades would weaken the incentives to clear. In addition,
ESMA does not see prima facie indications of any regulatory arbitrage opportunities (for
example, to use PTRR services in the EU to avoid a clearing obligation in a third country
because there has first to be an obligation to clear in the EU). However, there should be
some monitoring to check that it is indeed not the case, such that if it proved to
materialize, then this could be further addressed by regulation and/or supervisory
measures.
6.7 Would an exemption challenge the clearing mandate?
Policy makers and regulators have mandated clearing in liquid, standardised products
and introduced strict bilateral risk management practices in bilateral markets. This two-
fold approach helps to foster a safer, simpler and fairer financial sector. PTRR service
providers are supportive of this commitment.
Respondents note that PTRR exercises allow market participants to more efficiently
manage their collateral obligations, but do not undermine the objectives of the G20
reforms, nor negate the requirements for market participants to appropriately
collateralize their derivatives exposures. An exemption to the clearing obligation would
not exempt trades from the framework applicable to non-cleared transactions and trades
generated from PTRR services would be subject to the risk mitigation techniques
requirements under Article 11 of EMIR (including bilateral margining).
A few respondents mention that an exemption to the clearing obligation reverses the
logic of the G20 intention of risk mitigation for OTC derivatives. They argue that the core
concept of such reforms was that standardised OTC markets would be cleared, and thus
come under the multilateral netting and collateralisation imposed by CCPs and that more
exotic OTC derivatives would come under heightened capital and collateralisation
requirements, with the intention to better safeguard against their inherent risks and
incentivise market participants to employ standardised contracts when possible. In sum,
the purpose was to create more transparent markets, as well as to provide collateral and
capital buffers to help insulate market participants from each other’s counterparty credit
risk. One respondent noted that it was always understood that exotic or uncleared risk is
offset or hedged by standard OTC contracts would be cleared but does not provide
further details on how such a structure would look like.
It is further noted that several countries already have exempted PTRR transactions
resulting from portfolio compression from the clearing obligation. Based on this, such
respondents are of the view that the proposed exemption from the clearing obligation
would not contradict the G20 commitments but that this could contribute to improving the
way risk is managed. On one hand, central clearing was mandated for a set of
standardized contracts, including forward rate agreements (FRAs), interest rate swaps
(IRS) and CDS indices and on the other hand, uncleared contracts were to face higher
56
capital and margin requirements, primarily to better reflect their risk profiles but also to
promote central clearing.
Hence, two reforms have been implemented and whilst regulatory reforms promote
central clearing where possible, OTC bilateral portfolios still exist and are actively traded
between firms, containing trades; i) that are not suitable for clearing as not fulfilling the
eligibility CCP requirement for clearing, or ii) for which there is no widespread use of
clearing, e.g. cross-currency swaps (with the exception of NDFs), interest rate swaptions
and options (caps, collars, floors), single-name CDS and various types of equity and
commodity swaps.
ESMA also notes the following in the CCP 12 report “OTC Options have been launched
by CCPs, for example by the CME (Swaptions, FX Options) and recently LCH (FX
Options). So far, the market has chosen to continue trading these products bilaterally.
[…] In general, it remains a conundrum that large volumes continue to trade in exchange
traded options across a variety of asset classes, and yet OTC options remain largely
uncleared.” ESMA notes that this is an interesting aspect to investigate, it would however
not be relevant to assess this further under this report as it does not have a bearing on
the assessment of an exemption to the clearing obligation.
Based on this reasoning, ESMA considers in line with the view of market participants,
that it seems realistic to think that, in the future, the uncleared OTC products will remain
to be used and a large part of the derivatives market will remain bilateral. Today entities
still have bilateral exposures but while facing different counterparties, they would need
to use a service provider to compress their portfolios as multilateral compression and
rebalancing offer better possibility to find matching trades. ESMA also notes the
reflection in the CCP12 report that “Service providers who help to compress options
activity concentrate on a number of metrics to improve the profitability of options trading.
These include reducing gross notional, as well as lowering the gross amount of initial
margin that must be posted under the UMRs
41
. These are significant innovations from
the industry, but it remains the case that these activities would be more efficient in a
cleared model, where all risks could be multilaterally netted.”
6.8 The clearing obligation
The central clearing provides unique and superior risk mitigation benefits and features
are noted compared to bilateral trading, including the elimination of interconnected
bilateral counterparty credit exposures, a centralized default management process,
multilateral netting and compression opportunities, and transparent end-of-day pricing.
With regards to other viable alternatives to PTRR services, it is argued in the responses
that extending the clearing obligation to encompass all products that are currently
handled bilaterally would be an alternative.
41
Uncleared Margin Rules
57
One respondent notes that this would be a more efficient option, to clear both the
complex trade and its vanilla hedge into the same cleared netting set, which is less risky
and the most efficient in terms of capital. There would be no need for an exemption to
the clearing obligation as the clearing obligation itself makes this option the most risk
reducing and supports the incentives to centrally clear. This would, in a respondent’s
view, be compliant with the G20 reforms, to support a shift towards central clearing,
which is more cost/capital effective for the market participant.
This suggestion is though challenged by other respondents that note that extending the
scope of clearing to complex trades, which are often non-standard and highly illiquid, will
have significant impacts on the risk profile of a CCP which is why such trades were not
included in the clearing obligation in the first place. Respondents note that the trading
obligation and the clearing obligation are applicable where suitable and it is not a
requirement to clear all transactions.
The industry actively supports the clearing of suitable products but do not believe it is
appropriate to extend the scope of mandatory clearing to encompass all products that
might be found in the bilateral portfolios between firms. Such respondents note that using
an extended clearing obligation does not offer a full solution to increase the efficiency of
PTRR services and notes that for suitable products, the industry supports the ongoing
growth of clearing offerings as ultimately, the multilateral netting and risk management
benefits of clearing offer an efficient answer for such suitable products but PTRR
services play an important part in reducing risks in the bilateral markets by enabling firms
to effectively manage that risk in the most efficient way.
The underlying requirement to clear certain trades under EMIR, where pursuant to
Recital 21 of EMIR, ESMA, when determining whether a class of derivatives is subject
to the clearing obligation, should consider whether the clearing determination would
reduce systemic risk. ESMA, when identifying the classes of OTC derivative contracts
which should be subject to the clearing obligation, should pay due regard to other
relevant considerations and most importantly i) to the interconnectedness between
counterparties using the relevant classes of OTC derivatives and ii) the impact on the
levels of counterparty credit risk. It is noted in the responses that PTRR transactions do
reduce interconnectedness and reduces counterparty risks. Hence it could be argued
that PTRR transactions should not have been captured initially by the clearing obligation
and more relevant, that this is another argument why such trades should be exempted.
Based on above ESMA would agree that where trades are suitable for clearing in
accordance with the requirements provided under the regulations, clearing provides
additional benefits such as risk allocation to the CCP. At the same time, ESMA notes
that the clearing obligation should only apply to transactions that CCPs can effectively
risk-manage.
6.9 Optimising collateral use
One respondent notes that in addition to the clear risk reduction benefits for the
derivatives market, there is a not to be underestimated additional benefit of increase in
collateral availability with PTRR services. It is noted that many of the regulatory changes
since 2008 depend on collateral availability and despite the huge increase in government
58
and other types of bonds, availability of such high quality collateral is restrained for a
number of reasons and this can be observed in particular at quarter-ends but also in
stressed market conditions like the recent COVID-19 crisis. This aspect is discussed in
the market and a respondent notes that i.e. ICMA ERCC continues to encourage industry
wide discussions to optimise the use of collateral, avoiding a potential gridlock that would
jeopardise the important reforms so far achieved.
It is noted in the responses that market participants are incentivised to optimise or reduce
collateral as it is costly. The bilateral market has been calculating collateral on net basis
and managed risks and exposures through amendments, terminations, etc. One aspect
raised in relation to PTRR services is the concern that by using compression and risk
mitigation through offsetting trades, the market might become “under collateralised”, this
is according to many respondents not to be the case as the collateral would still be the
correct amount required by regulation.
IOSCO notes that PTRR services aim to reduce “outstanding gross notional value of
non-centrally cleared OTC derivatives transactions, allowing for increased capital
liquidity and efficiency”. The CCP12 Report points out that the uncleared margin
requirements are providing suitable incentives to clear as well as leading to innovations
in reducing bilateral counterparty exposure using multilateral optimisation services to
offset risk between uncleared and cleared. The report further notes that the BIS data
shows that Gross Market Value (“GMV”) has consistently dropped in IRDs over the past
few years and that the drop in GMV is due to innovations in clearing as compression
reduces GMV by removing redundant, off-market and off-setting swaps, therefore
reducing gross mark- to- markets.
In the responses it is mentioned that the trading activity in uncleared OTC derivatives
would increase due to the proposed exemption and more trading activity would be
uncollateralized because the uncleared initial margin requirements have yet to be
implemented for the vast majority of the dealer-client relationships. There are two issues
reducing the effectiveness of the uncleared initial requirements in incentivizing central
clearing.
Firstly, the “quantitative data suggests that the difference between required cleared and
uncleared initial margins is less than expected, with the CFTC research finding that the
uncleared margin required for certain portfolios can even be lower than the
corresponding cleared margins, specifically as low as “54% of the ‘all-risks’ cleared
margin for the same portfolio.””
42
Secondly, the “uncleared initial margin requirements
have yet to be implemented for the vast majority of the dealer-client relationships,
meaning that it still may be less costly for dealers to transact with clients on an uncleared
basis”. Such respondent note that in the absence of uncleared initial margin
requirements for dealer-to-client trades, voluntary clearing rates, for many standardized
42
The respondent notes that this research also found that 32% of dealer firms had higher cleared margin requirements (vs
uncleared) when all initial margin costs were included. Roberson, M., “Cleared and uncleared margin comparison for Interest
Rate Swaps,” CFTC staff paper (April 2018) at page 10, available at:
https://www.cftc.gov/sites/default/files/idc/groups/public/%40economicanalysis/documents/file/dcr_cleared_uncleared_margin.pd
f.
59
OTC derivatives not yet subject to a clearing mandate, such as interest rate derivatives
in non-mandated currencies, single-name CDS, CDS referencing non-mandated indices,
and FX non-deliverable forwards, remain at low levels even though viable clearing
offerings exist.
The respondent further notes that as a result, the clearing obligation remains critically
important in ensuring that liquid and standardised derivatives are centrally cleared, as
set forth in the G-20 reforms. While the uncleared trading activity and exposures of any
given dealer-client relationship may not present systemic risk concerns in isolation, the
number of bilateral exposures exempted from uncleared initial margin requirements can
create systemic risk in aggregate. Therefore, any exemptions from the clearing obligation
should be extremely limited in scope, and policymakers should clearly understand the
impact of any exemption before allowing it.
Another respondent notes that the reduction of margin is a consequences of “risk
reduction” services and notes that while a reduction of notional amounts would not lead
to situations where the market is undercollateralized and vulnerable in times of stress, it
does make the capital and collateral costs for the market participant cheaper. This results
in a substantial shift of risk towards the bilateral space, and that PTRR services do not
bring the financial stability benefits of central clearing.
Such respondent agrees that PTRR services clean up line-by-line items but do not
evaluate and collect the appropriate collateral needed to face counterparty credit risk,
nor do they have comprehensive default management processes to address eventual
defaults and is therefore sceptical that such an exemption would help better to manage
counterparty credit risk for the financial system as a whole. By exempting rebalancing
trades will further reduce uncleared initial margin requirements while enabling market
participants to circumvent the clearing obligation and significantly increase trading
activity in uncleared OTC derivatives.
Those arguments are challenged by several respondents noting that it is not a problem
that the collateral is reduced if the counterparty risk is reduced and no systemic risk can
be identified in using PTRR services and as long as the regulatory requirements are met,
no risks with reducing collateral is identified.
One respondent highlights that it is important to understand that, for the same risk model,
an increase in collateral is indicative of an increase in risk. As collateral increases across
bilateral portfolios, it is not safe to conclude that, in some way, the system is “better
protected”. Instead, a safer conclusion is that risk increases. Under an exemption regime,
collateral in bilateral portfolios would reduce because the counterparty risk in these
portfolios would be smaller, representing a better systemic risk profile. In the end, it is
mentioned, a reduction in collateral is only a reflection of lower collateral needed as
shown by various regulatory metrics. Freed up collateral could be used to better service
clients or reduce pressure on funding markets. The focus should therefore be on the
reduction of the need for collateral, rather than concentrating on ever increasing
collateral balances for increased risk exposures.
Based on this reasoning, ESMA considers that margin requirements are a separate
question from the assessment to be undertaken under this final report, which focuses on
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whether PTRR transactions should be exempted from the clearing obligation for reasons
of risk reduction and risk optimisation in the market, simplicity and accessibility.
Whilst the margin requirements under EMIR are very important, ESMA does not find the
argument that PTRR transactions should not be exempted as there would be too low
margins on them as a valid argument for this report. That the margins are too low may
be a valid conclusion but is not relevant in relation to the assessment at hand, whether
an exemption or not will be provided.
Hence, to “cure” any identified lack of requirement to post collateral of uncleared trades
through the position to not grant an exemption for PTRR transactions would not be the
right means. It is important to keep the PTRR services and their aim separate from any
identified lack of margin requirements under the relevant regulation.
6.10 Circumvention of the clearing obligation
EMIR Refit requires that before granting any clearing exemption, regulators must assess
if such exemption would lead to a circumvention of the clearing obligation. PTRR
services resulting in transactions subject to the clearing obligation may today either be
avoided by not undertaking the PTRR exercise or by using transactions not subject to
the clearing obligation.
As vanilla trades resulting from PTRR services would be exempt from the clearing
obligation, it is argued that less trades would be subject to the clearing mandate, thereby
weakening the ‘obligation’ in itself and the G20 objectives and such exempted trades
could be used to extract vanilla trades already in cleared portfolios, thereby reversing the
shift towards central clearing.
To assess the risks of circumvention by allowing certain PTRR transactions to be
exempted from the clearing obligation is difficult, mainly for the obvious reason that the
PTRR transactions would most likely not have occurred at all today due to the clearing
obligation. The question therefore is whether an exemption would incentivise market
participants to use this technique as a way to avoid clearing.
One respondent noted that an exemption to the clearing obligation would open up
significant possibilities for regulatory arbitrage and ‘clever’ trading to extract trades
already present in cleared portfolios and to bring them back into the uncleared space.
ESMA has noted in the responses this argument that cleared trades are reduced or
shifted to the bilateral sphere, however ESMA is not clear on how this would be done.
There is the possibility where a replacement trade (exempted from the clearing
obligation) is used to replace cleared trades in a CCP, however this requires that the
compression contains both cleared and uncleared portfolios in the same compression
cycle hence suitably framed and calibrated exemptions should avoid such outcome. The
scenario on how to extract cleared trades from a CCP is assessed above under Section
6.3.1.
One respondent noted that whilst it could imagine scenarios in which incentives to
perform such circumventing activity might be created this would require PTRR services
to be undertaken without an applied regime and requirements.
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Many respondents are of the view that the likelihood of a circumvention of the clearing
obligation will turn out to be, de facto, extremely low. One respondent found it extremely
difficult to imagine a “real” scenario where what is mentioned above could materialise.
Many respondents support the use of conditions to avoid any risk of circumvention of the
clearing obligation. Some requirements for PTRR services noted in the responses
include such services (i) being market risk neutral, (ii) reducing the bilateral risk in the
portfolio into which it is booked, and (iii) carried out by an independent service provider,
i.e. none of the participants should be able to influence the outcome of the exercise and
no pick and choose among the trades. Based on this the view is that, any such exemption
of such trade would not act as an incentive not to clear the primary underlying trades.
One respondent critical to an exemption requests ESMA to provide the data for the
current size of standardised risk that currently resides in bilateral portfolios as such
respondents then envisage it possible to estimate the type of participant and scale of
plain vanilla OTC derivatives that would be added to bilateral portfolios. It would also be
incisive to consider how much capital and collateral such moves would free up.
ESMA considers that whilst relevant data generally should be used, ESMA would though
note that collecting data as suggested by the respondent in relation to PTRR services is
not possible for two reasons: how would “standardised risk in a bilateral portfolio” be
defined when risk is based on counterparties sensitivities and secondly to assess the
changes to collateral is again not possible as it would depend on the overall position of
the counterparties and their risks preferences.
In addition, today PTRR services do not use cleared trades to mitigate risk in an
uncleared portfolio as this would delink such trades from the risks they are managing.
Hence, uncleared trades are used, arguably with some drawbacks in some cases. This
would mean that there is no reduction in cleared trades as the trades were never entered
into in the first place and there is no data to be provided of cleared transactions that
would instead be uncleared (with an exemption).
ESMA notes that it is important to bear in mind the underlying contractual freedom of
counterparties, i.e. bilateral counterparties may at all time trade bilateral trades and use
uncleared trades to mitigate risks.
ESMA considers, in line with respondents, that the design of an exemption must take
into account strict conditions to prevent any misuse of PTRR exercises.
6.11 Conclusion
ESMA has in cooperation with the ESRB and in accordance with the mandate,
investigated portfolio compression and other available PTRR services, mainly
rebalancing/optimisation services and provided explanations on the purposes and
functioning of such PTRR services and the risks they mitigate. ESMA has also
investigated to what extent any exemption from the clearing obligation for such services
may discourage central clearing and may lead to counterparties circumventing the
clearing obligation.
ESMA would, based on the assessment undertaken and the responses received,
conclude that PTRR services, primarily compression and optimisation/rebalancing, are
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very useful tools to manage risk in both cleared and uncleared portfolios. ESMA notes
that such PTRR transactions are different from “ordinary” traded instruments, as PTRR
transactions are a direct result of a PTRR exercise, established on “old” prices and not
subject to negotiation between the parties but established by applying an algorithm to
submitted portfolios of trades that the parties would like to compress or rebalance.
One of the arguments presented against an exemption to the clearing obligation in the
responses is that PTRR services used by market participants have steadily increased
without being negatively affected by the clearing obligation. ESMA agrees that PTRR
services have successfully reduced a significant amount of risks in the market to date.
However, whilst those numbers are significant, they do not provide any evidence on the
question if they are hampered by the clearing obligation as the compression today is
undertaken in accordance with the regulatory requirements of today. On the contrary,
ESMA understands based on the evidence submitted in the consultation that the
requirement to clear any PTRR trade subject to the clearing obligation hampers the use
of PTRR services today.
ESMA notes that the G20 commitment to improve the OTC derivatives market include
the reporting obligation, the trading obligation, the clearing obligation and the
requirement to increase use of collateral and risk mitigation techniques. Hence, the G20
commitment does not prevent an exemption to the clearing obligation, as the requirement
to clear applies in conjunction with the requirement to increase the use of risk mitigation
requirements targeting the uncleared market and MiFIR already contains an exemption
from the trading obligation for PTTR trades.
ESMA notes that PTRR services for compression today use termination (partial or full,
no replacement trades are created) when compressing trades uncleared but subject to
the clearing obligation (legacy trades such as CDS) and for rebalancing the service use
uncleared trades (swaptions) to hedge the i.e. interest rate risk of the uncleared portfolio
instead of the clearable instrument (IRS). This has two consequences, the participants
effected by the use of more complex products (as not all market participants can manage
such more complex trades) and participants that have concerns with the use of uncleared
trades to avoid the clearing obligation, may opt not to use PTRR services today and this
is in the end negatively effecting the risk management possibility of exiting portfolios of
trades that would not be in line with the G-20 commitment.
ESMA has noted some scepticism on the possibility for exempting such PTRR
transactions from the clearing obligation and further assessed the risks those
respondents have raised regarding an exemption to the clearing obligation. One of the
main arguments is that an exemption would reduce the amount of trades cleared today.
ESMA did not find any evidence that introducing a clearing exemption for PTRR trades
would have this effect. In fact, today the clearing obligation simply prevents such PTRR
trades to be performed, as they would need to be cleared.
PTRR services are different to CCPs but have some common valuable features of aiming
to reduce different risks in the market. However, ESMA notes that not all trades are
suitable to be cleared due to liquidity or complexity and there are already procedures in
place under other regulations regulating what type of trades are suitable to be subject to
the clearing obligation. ESMA notes the opposing positions in the responses; on one
side, allowing for a limited exemption to the clearing obligation in order to increase the
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efficiency and accessibility of PTRR services; compared to the other side, suggesting
moving more transactions (if not all) to clearing with CCPs as this would also increase
efficiency and avoid the issue of today of having the cleared and uncleared netting sets
sitting at counterparties. ESMA notes that to clear all trades at a CCP is not in line with
the regulatory requirements and is not a viable way forward.
ESMA has also noted the concern on the reduction of margin and agrees that any
reduction of margin should be in line with the regulatory requirements applying to the
market today as uncleared trades are subject to specific margin requirements in line with
the G20 commitment. ESMA is not convinced by the argument that because the bilateral
margin requirements are not resulting in enough trades being collateralised due to
phase-in provisions or that an exemption would limit PTRR transactions to fall under the
margin requirement’s regime for uncleared OTC derivatives. Any drawbacks or limitation
in relation to the applicable margin requirements would need to be managed through any
future review of the relevant regulations but cannot be considered in this assessment of
a possible exemption to the clearing obligation.
One aspect raised in the responses is on legal certainty and the legal consequences
related to replacement trades in the execution of the relevant transaction. ESMA agrees
that legal certainty around the effectiveness and timing of the trades is essential and
should, where needed, be considered as part of a regulated exemption.
ESMA also notes the concerns raised from a more fundamental point of view, that no
exemption to the clearing obligation should be made, as it will by definition reduce the
incentives to clear. It is noted that there already are difficulties to ensure all trades
suitable for clearing are cleared and that all participants that are obligated to clear, have
reasonable tools to access clearing and to meet its obligations to clear on a fair term.
Whilst ESMA fully agree that there are remaining issues on ensuring clearing are
accessed and used to the fullest extent possible (within the remits provided by law)
ESMA would not like to use the assessment as to the reasonableness and need for an
exemption to the clearing obligation in the assessment on overall issues with
accessibility.
ESMA notes that on the contrary, an exemption to the clearing obligation would simplify
and require the parties to enter into risk offsetting trades with the CCP to shift the risk of
their uncleared portfolio into the CCP, and this would be simplified by using the same
type of transactions in the uncleared and cleared portfolio.
Not allowing for an exemption will probably only provide a further split in the market
between cleared and uncleared as the possibilities to risk mitigate between the both
portfolios will be reduced for the majority of the markets participants and hence possibly
rather incentivise the use of uncleared trades to ensure all trades are within the
uncleared portfolio rather than managing both cleared and uncleared portfolios as not
yet all trades may be cleared.
Another fundamental aspect raised by a respondent is that from a financial stability
perspective, exemptions to the clearing obligation should only be considered when they
contribute to reducing systemic risk, subject to appropriate safeguards to avoid the risk
of regulatory arbitrage. ESMA agrees with this remark, and notes that PTRR services
demonstrably reduce systemic risk compared to a scenario where an exemption to the
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clearing obligation is not granted and that the proposed exemptions would be subject to
requirements aimed to manage risks of circumvention.
To conclude ESMA notes the following aspects.
Exempting certain compression or rebalancing trades from the clearing obligation
enables participants to reduce risk in the non-cleared netting sets. This reduction in risk
on the individual level also results in an overall reduction of systemic risk. ESMA views
this as a desirable feature.
PTRR compression services are successfully used today and have successfully
compressed portfolios of uncleared or cleared trades, but legacy trades (and future
legacy trades) cannot be compressed due to the clearing obligation.
PTRR rebalancing services are successfully used today, but that using complex products
to reduce a simple, for example, interest rate risks, runs three risks, added complexity in
the portfolios, reduced participation due to complexity service; and risk of circumventing
the clearing obligation by using uncleared alternatives.
ESMA notes that some, including the ESRB, are of the view that preventing the clearing
obligation from being circumvented should take priority over lifting the clearing obligation
to facilitate the use of PTRR services. ESMA very much agrees that the clearing
obligation is an important and fundamental cornerstone in ensuring financial stability but
notes that also PTRR services results in ensuring financial stability. Hence, in the
absence of compelling evidence or reasoning to the contrary, ESMA believes the
benefits of reducing market risks in the non-cleared netting sets outweigh, inter alia, the
increased potential operational burden on market participants and regulators, the
increase in gross risk in the non-cleared netting sets (in case of portfolio rebalancing)
and the remote risk of market participants possibly evading the clearing obligation via
the exemption (gaming).
ESMA also notes that an exemption to the clearing obligation would ultimately result in
an increase of the trades at the CCP, as the counterparties would be required, to the
maximum extent possible, to voluntarily shift risk to a CCP after undertaking a PTRR
exercise.
ESMA concludes that PTRR services are an important tool to manage risk and the
respondents to the consultation have provided valid arguments of why an exemption
would improve the use of PTRR services and increase its accessibility. At the same time,
the fundamental starting point is contractual freedom and parties may compress and
rebalance their portfolios as they would want to as long as the services do not generate
a cleared trade (unless intended). Based on this, ESMA has formulated a core question,
would it be preferable for the market to continue as it is now, i.e. with some limitations
on compression (primarily for legacy trades), with only the most advanced market
participants undertaking PTRR exercises and using more complex products (where
possible), or not?
Based on above, ESMA supports an exemption to the clearing obligation for PTTR
trades, as it would allow to treat legacy trades equally with other uncleared trades
(including a possibility to compress them), and overall increase the accessibility of PTRR
services for market participants.
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ESMA would support data to be assessed once the new reporting RTSs have been
adopted and implemented, to assess, if possible, how the exemption to the clearing
obligation have increased access to PTRR services.
To ensure that an exemption would not be misused ESMA has assessed different types
of conditions to apply to an exemption, they are set out in Part 3.
PART 3
7 Possible requirements for the provision of PTRR services
ESMA considers that there is merit in considering an exemption to the clearing obligation
for trades resulting from PTRR exercises when they comply with certain restrictions and
ESMA has thoroughly assessed the requirements that would be recommended to apply
where PTRR service providers apply the exemption to the clearing obligation.
7.1 PTRR service providers acting independently
One of the questions identified is how to avoid inappropriate influence of the participants
over the PTRR service provider. If the PTRR provider was not bound by conditions, there
is the risk that participants could cherry-pick which transactions submitted to the PTRR
service provider would eventually get executed (and which would not). Similarly, if there
were no requirements on the PTRR exercise to reduce risk in portfolios, then there would
be a risk that PTRR services could be used to add trades under the perception that they
are exempted from the clearing obligation just by the fact of being part of a PTRR
exercise. A way to mitigate these risks (and this is already noted under MiFIR) is to
provide clear remits and requirements to PTRR services to ensure they are not used to
avoid the clearing obligation.
The process today seems to be that the participating counterparties decide on the
transactions to be included in the portfolio which is submitted to the PTRR exercise.
Once the parties have submitted their portfolios, it is understood that they have no further
influence over the exercise. With some PTRR services such as portfolio compression,
the parties may set tolerance levels to provide the remits of the exercise, but the
participants influence is expected to end with the submission of the portfolio, as then it
is the PTRR service provider who applies its algorithm to complete the PTRR exercise.
This means that after the PTRR service provider runs the PTRR exercise on such
portfolio, the counterparties may or may not undertake the suggested resulting PTRR
transactions, but they cannot influence or change the result of running the PTRR service
provider’s algorithms. The service provider analyses the portfolios of the participants and
publishes the optimal solution. The outcome depends on which method the PTRR
service provider will use.
The question is how to ensure that the PTRR service provider is independent in its
assessment and that market participants cannot have an influence in the solution
proposed by the provider.
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7.1.1 Feedback
Respondents note that PTRR services should be carried out by an independent service
provider to avoid participants, subject to the clearing obligation, deciding whether to clear
a trade or not. Rather, PTRR exercises should be performed by PTRR service providers
independently of the market participants.
Another point raised in the responses is that the outcome of the PTRR exercise should
operate on an all-or-nothing basis. Market participants should submit their portfolio and
the third-party service provider would then calculate the appropriate adjustments in the
form of PTRR transactions needed to best manage the risk in the portfolios submitted
and propose the adjustments to the market participant. Participants to the PTRR exercise
should not have any influence in the designation of the adjustments proposed base on
the algorithm and must either accept or reject in full the proposed adjustments. The tasks
of the PTRR service provider should be limited to receiving the information regarding the
participants portfolios and tolerances, carry out calculations based on algorithms and
submit the outcome of these calculations to the participants as a package (for them to
accept or reject) without providing any advice. The exercise would be void if not all
participants accept the proposed outcome. In the responses there is a proposal to
suggest that a suitable initial governance framework is put in place that mandates the
“automatic” treatment of outputs (i.e. no manual intervention or de minimis).
Another respondent noted that PTRR service providers should keep records of the
transactions inserted into the bilateral portfolios, the risk of these portfolios before and
after the exercise and the transactions to shift risk to the CCP. This information would be
available for regulators to monitor whether conditions to benefit from the exemption are
met. Trade linkages could also, where applicable, be reported as part of EMIR and MiFIR
transaction reporting (the functionality to provide trade linkages already exists in
middleware platforms such as MarkitWire and DSMatch).
Such data would also allow to review, after each PTRR exercise (where needed), that
for each PTRR transaction inserted into the bilateral portfolios, an equal and opposite
transaction has been booked into a CCP (on a net basis) and that the risk in each
affected bilateral portfolio has been reduced.
Other respondents, sceptic to the exemption to the clearing obligation noted that
requiring PTRR exercises to be performed by an independent service provider does not
alter the commercial incentives that individual traders would have (leveraging on a
clearing exemption) to enter into uncleared OTC derivatives in the first place, with full
knowledge that they could later be hedged using uncleared vanilla instruments that are
normally subject to the clearing obligation.
7.1.2 Considerations
After considering the feedback received, ESMA is of the view that in order to benefit from
an exemption from the clearing obligation, a PTRR exercise needs to be conducted by
an independent third party PTRR service provider.
Hence, one requirement for the provision of PTRR services could be that the transactions
shall be (i) generated in accordance with a service provider’s established rules and
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parameters for compression exercises, (ii) the exercise shall be conducted
independently by the PTRR service provider acting as a third-party, and (iii) the proposal
can only be fully accepted or rejected without giving the possibility to market participants
to choose which trades they agree to and which not, and if only one rejects it in part or
in full, the entire exercise is void. The objective of such independent requirements would
be to avoid any influence of any market participant on the direction or result of the
proposed outcome in a PTRR exercise.
An aspect that is closely linked to the independence of the service provider is the conflict
of interest aspect. It is noted in the responses that the independence of a service provider
could be compromised in a system where clients who pay for the service set the
tolerance levels that the service provider will apply to their portfolios. In addition, as a
respondent noted, service providers can be part of a financial group or be owned by their
customers and this could lead to a potential conflict of interest that should be taken into
account if governance requirements would be assessed.
7.2 Build-up of transactions
ESMA identified in the consultation paper the possible concern regarding the build-up of
non-cleared transactions booked as part of the optimisation process after the PTRR
service provider has proposed a solution to reduce risk and the participants in the
exercise have agreed to it. The concern is that the new transactions booked by market
participants would increase the total number of transactions and that this needs to be
prevented by mandating a compression after each rebalance exercise and before
running the next cycle.
The consultation paper investigated whether there is the possibility that a PTRR
rebalancing exercises could result in a build-up of transactions as a result of the need to
constantly manage risks that are constantly subject to changes and if a condition to
regulate this should be envisaged.
7.2.1 Feedback
ESMA notes that the market seems to self-regulate this concern as it is in the interest of
the participants (particularly rebalancing conducted with more complex products that
contain expiry features) to constantly compress such trades and in addition ESMAs
understanding is that rebalancing transactions are often short dated to avoid a build-up
of transactions. It is also in the interest of the providers to deliver efficient PTRR services
and to continuously compress the rebalancing trades.
7.2.2 Considerations
ESMA is of the view that build-up of transactions should be limited and that after each
rebalancing cycle and before the next, a compression exercise should be performed
where needed. In addition, ESMA is aware that this is already a practice conducted by
PTRR service providers and this condition should therefore not be too burdensome as it
merely confirms the practice undertaken today.
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8 Summary of key features and requirements
ESMA concluded above that an exemption to the clearing obligation is justified based on
the assessment and analysis undertaken by ESMA. However, due to the development
in the market ESMA also notes that some of the characteristics of the services may
change due to developments in the provision of post-trade reduction services, hence the
key features of compression and rebalancing are noted below providing the remits of the
services assessed in this report.
8.1 Proposed requirements for the provision of PTRR services to
benefit from an exemption to the clearing obligation
ESMA has, as noted above, thoroughly assessed the requirements that should apply to
the provision of PTRR services, where PTRR service providers apply the exemption to
the clearing obligation the following requirements apply on the provision of the PTRR
service:
a) PTRR exercises should be performed by service providers independent of the market
participants, i.e. independent of in-house traders, to avoid gaming and to avoid any
conflict of interest.
b) The service provider shall ensure that the compression and rebalancing exercises are
provided on fair, reasonable and non-discriminatory terms and conditions.
c) The PTRR service providers should keep records of the transactions inserted into the
bilateral portfolios, the risk of these portfolios before and after the exercise and the
transactions to shift risk to the CCP (where used).
d) The service providers shall monitor the services they provide to ensure (to the extent
possible) to adhere to the purpose of the service, post-trade risk mitigation through
compression and rebalancing and should not assist in any misuse or intended
circumvention to the clearing obligation.
e) The service provider shall only apply the clearing exemption to transactions that directly
derive from PTRR services described as portfolio compression transactions and
portfolio rebalancing transactions, and that comply with the conditions to benefit from
the clearing exemption as listed below.
f) The service provider should provide PTRR exercises under clear remits and in
accordance with the provider’s established rules, methods and algorithms; and
participants, after submitting the portfolios they want to compress or rebalance, should
have no influence in the result of the exercise.
g) The proposed PTRR trades after the service provider has completed the compression
or rebalancing cycle, can only be fully accepted or rejected (the “all or nothing
approach”), without giving the possibility to market participants to choose which trades
they agree to execute and which not.
h) Counterparties entering into a PTRR transaction as a result of a compression or
rebalancing exercise must be participants of the PTRR exercise. No third-party that
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was not part of the PTRR exercise can enter into any of the resulting PTRR
transactions.
8.2 Conditions to benefit from the clearing exemption on trades
resulting from portfolio compression
In a compression exercise, the exemption from the clearing obligation should only apply
to PTRR trades directly resulting from compressions of uncleared transactions (primarily
legacy transactions, i.e. trades that are uncleared today but would technically be subject
to the clearing obligation (current and future ones) and rebalancing transactions).
A portfolio compression service should be run on a multilateral basis.
Compression should show that the risk in each affected bilateral portfolio has been
reduced.
Compression is market-risk neutral in risk-free compression (no replacement trades),
however where replacements trades are executed the market-risk is materially market
risk neutral.
Each participating firm in a compression exercises provides its tolerances or sensitivities
of their portfolio to the PTRR service provider which are then binding on participants. The
tolerances provided by the participant should be applied equally to the participants in the
rebalancing service except for tolerances derived from counterparty credit risk. In a
compression exercise, the total risk exposure cannot increase by more than the pre-
agreed tolerances (market risk) on any bilateral portfolio.
For each replacement transaction resulting from risk reduction exercises, an equal and
opposite transaction must be booked facing a CCP, to the maximum extent possible
43
.
8.3 Conditions to benefit from the clearing exemption on trades
resulting from portfolio rebalancing
In a rebalancing exercise, the exemption from the clearing obligation should only apply
to PTRR trades directly resulting from rebalancing of portfolios of only uncleared
portfolios or mixed portfolios compounded of cleared and uncleared trades.
Portfolio rebalancing transactions offsets part of the risk between the parties but does
not close out or terminate any trades in the underlying portfolio, those trades remain
outstanding between the parties.
Portfolio rebalancing adds new transactions based on risk sensitivities of the underlying
portfolio and not based on the individual transactions within the portfolio, meaning that
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ESMA notes some possible restrains on the accessibility to CCPs by some entities. Based on this a requirement to enter into
“equal and opposite trades” may be too burdensome and unproportionate to apply to such entities, and in contradiction of the
aim of increased use of PTRR services.
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the rebalancing trade will be different from the original trades which contribute to the
underlying risk exposure.
Rebalancing services are run on a multilateral basis.
Where a portfolio rebalancing contains both cleared and uncleared portfolios, a
rebalancing transaction mitigating risks in a cleared portfolio, shall be cleared with a CCP
to remain with the portfolio it manages the risk in.
Portfolio rebalancing need to demonstrate that the risk in each affected bilateral portfolio
submitted has been reduced.
A portfolio rebalancing exercise is market risk neutral (this is ensured by inserting equal
amounts of buy and sell exposures, facing different counterparties in the rebalancing
exercise). Hence, in a rebalance exercise, for each participant to the exercise, the net
risk of the new rebalancing trades must amount to zero.
In order to prevent a build-up of transactions in portfolios, after each rebalancing cycle
and before the next, a compression exercise needs to be performed where a material
amount of rebalancing remains outstanding between the participants from the previous
exercise.
Rebalancing transactions must transfer risk (on a net basis) to a CCP to the maximum
extent possible.
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Annex 1: Portfolio rebalancing
44
How the portfolio rebalancing service works in terms of reduction in the sum of “bilateral” net
exposures within a mixed portfolio, where the CCP is treated as the other bilateral
counterparties. The example envisaged a mixed portfolio made up of three bilateral
counterparties (A, B and C) and a CCP. The various counterparties have DV01 sensitivities
with each other as reported in Table 1.
Table 1 – Initial portfolio exposures
A
B
C
CCP
Net
Sum Abs
A
0
12
-10
6
8
28
B
-12
0
-6
14
-4
32
C
10
6
0
-3
13
19
CCP
-6
-14
3
0
-17
23
102
For each counterparty the sum of “bilateral” net exposures (in absolute values) is much larger
than the net one. In this scenario rebalancing transactions should be the ones reported in Table
2.
Table 2 – Rebalancing transactions
A
B
C
CCP
Net
A
0
-3
5
-2
0
B
3
0
1
-4
0
C
-5
-1
0
6
0
CCP
2
4
-6
0
0
The rebalancing transactions are market neutral and each counterparty has an equal amount
of buy and sell exposure facing the other counterparties. As a result of the injection of these
rebalancing trades the new DV01 sensitivity of the mixed portfolio is the one shown in Table
3.
Table 3 – Final portfolio exposures
A
B
C
CCP
Net
Sum Abs
A
0
9
-5
4
8
18
B
-9
0
-5
10
-4
24
C
5
5
0
3
13
13
CCP
-4
-10
-3
0
-17
17
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While the net exposures of each counterparty are unchanged, the sum of “bilateral” net
exposures has decreased from 102 to 72 with a reduction of 29%.
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Source of the data: TriOptima.
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Annex 2: Cost Benefit Assessment
In order to assess the effects of an exemption to the clearing obligation, ESMA requested (if
possible) to receive data and other information on the possible costs or benefits of an
exemption to the clearing obligation. Several responses were received and some aspects are
referenced below.
ESMA received some interesting responses, however, less on data but more on the general
assessment as to the costs and benefits of an exemption.
Regarding the benefits of an exemption from the clearing obligation, respondents highlight that
on the one hand, compression helps to reduce risks such as counterparty, operational and
ultimately systemic risks, by reducing the number of trades and/or notional exposure among
counterparties and; on the other hand, it is challenged as limiting or disincentivising the clearing
obligation.
To reduce systemic risk, this may be done by involving a CCP (where possible) to reduce
counterparty risk (as it is further explained in Section 5.2.6 An “equal and opposite” trade
booked facing a CCP).
Operational risk is also reduced by the reduction in exposure and by managing risk by
improving the efficiency and transparency of portfolios.
8.4 Cost
One respondent notes that most costs they have identified will not be significant compared to
benefits, with the potential exception of capital requirements for firms constrained by notional
driven measures.
Such respondent notes that constraints driven by notional, for instance capital requirements,
the leverage ratio, the GSIB surcharge and US stress tests might increase if the PTRR exercise
adds many new trades to the uncleared portfolios. While this cost can be mitigated by careful
design of the PTRR algorithms, these constraints might affect the extent to which firms will
utilise PTRR services.
The cost of the services are noted, stating that there will be transaction cost to each PTRR
service run and participants would likely not participate in a PTRR exercise where the benefits
(saving in margin, capital requirements, gross notional and operational complexity) will not
outweigh the cost.
The cost of the provider is an important aspect and ESMA notes that to increase access to
compression services costs may be a limiting factor, as less advanced participants may
contribute with smaller portfolios of trades but possible important trades bearing in mind
different directional preferences in the market, but such participants may have less resources
to participate in PTRR services and in particular if they are too expensive. Another angle to
costs is that regulatory requirements bear a cost, hence any additional requirements and
increased costs of complying with requirements and supervisory costs, will be reflected in the
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fees of the services, hence whilst it is important that PTRR service providers are regulated
appropriately, the common good of accessibility to such services are vital to achieve efficiency.
It is noted that an exemption to the clearing obligation might be seen as a “regulatory cost”.
However, the exemption from the clearing obligation will support overall risk reduction. ESMA
would be inclined not to view an exemption as a regulatory cost as such an exemption would
be in line with the underlying G20 principles of reduction in risks and would only exempt certain
non-price forming administrative trades.
8.5 Benefits
Several respondents consider that the benefits of an exemption materially outweigh the costs
above:
§ Overall risk reduction (counterparty risk, collateral risk, systemic risk);
§ Reduction of default competition risk;
§ Reduction of liquidity risk driven by margin payments;
§ Reduced margin requirements, leading to reduced liquidity risk.
Should PTRR services manage to reduce the majority of the interest rate delta (assume 90%),
SIMM margin would reduce by 15.3%. With margin being a proxy of risk, it could also be
assumed about 15% of total risk has been reduced. Based on total margin of USD 82.1bn from
the 2019 SIMM back-testing, this would result in a reduction of margin requirements of USD
12.6bn. Reduced margin requirement are also a proxy measure for reduced counterparty risk
in the uncleared portfolios.
It is also noted that the overall proportion of risk warehoused at the CCP (rather than bilaterally)
will be increased as the possibility to enter into equal and opposite trades (at least on a net
basis) will be simplified which will also increase clearing volumes.
8.6 Liquidity
One respondent noted that under normal market conditions, gross payments and receipts
would be between three or four times the net VM for bilateral portfolios but during the recent
stressed period from mid-March, net VM changed only modestly (typically two to three times)
however, gross VM paid and received increased from the order of three or four times to the
order of ten to twelve times. The respondent highlights that significantly increased liquidity
requirements exactly when funding markets might be less liquid. Acadiasoft, on 2nd June 2020,
published a paper “Smooth Sailing Through the Perfect Storm”
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-that sets out the significant
increases in Variation Margin on bilateral trading that arose during the Covid-19 crisis in March
2020. The analysis shows how collateral flows increased to around 350% of their typical levels
in prior months. Broadly, during March 2020, around USD 260bn of liquidity was being utilised
45
https://acadiasoft.com/smooth-sailing-through-the-perfect-storm/
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each and every day in settlement of these obligations. Large offsetting bilateral credit risks will
have contributed materially to these amounts.
Another point raised is the cost of not having a clearing exemption, which entails the use of
more complex products (e.g. swaptions) instead of simpler vanilla products that are under the
clearing mandate. These synthetic workarounds introduce new risks to be managed.
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Annex 3: High-level matrix over exemptions for portfolio compression in other
jurisdictions
Country
Applied conditions and
independent service provider
Portfolio of only
uncleared transactions
Only multilateral
compression
Same CPs
Reduce notional
Reduce risk
US
Each amended swap(s) or
replacement swap(s) generated
by the multilateral portfolio
compression exercise must:
- be generated in accordance
with a multilateral portfolio
compression service provider’s
established rules and
parameters for multilateral
portfolio compression exercises;
and
- the “multilateral portfolio
compression exercise”
generating the amended and
replacement swaps must meet
the definition set forth in
Commission regulation
23.500(h).
Once the original swaps have
been selected and submitted by
market participants as part of the
multilateral portfolio compression
exercise, the multilateral portfolio
compression methodology does
not permit participants to specify
which swaps may be amended or
replaced.
2. No original swap
submitted by market
participants as part of the
multilateral portfolio
compression exercise
shall include any swap
that has been cleared by a
DCO.
3. No original swap
submitted by market
participants as part of the
multilateral portfolio
compression exercise shall
include any swap that is
required to be cleared
under 2(h)(1)(A) of the
CEA and part 50 of
Commission regulations
because it was executed
on or after an applicable
compliance date.
“[…] and must involve more
than two market
participants.”
b. be entered into
between the same
counterparties as the
original swap(s) that is
amended or terminated;
c. with the exception of
reducing the notional
amount, have the same
material terms as the
original swap(s), as defined
in part 45 of Commission
regulations,10 including the
reference entity, the
maximum maturity of the
swap, and the average
weighted maturity of the
swap; and
d. be entered into for the sole
purpose of reducing
operational or counterparty
credit risk.
“replace the terminated
swaps with other swaps
whose combined notional
value (or some other
measure of risk) is less than
the combined notional value
(or some other measure of
risk) of the terminated swaps
in the compression exercise”
Australia
(a) the Clearing Transaction is
entered into by the Clearing
Entity as a result of the Clearing
Entity modifying or terminating
and replacing Derivatives under
a Multilateral Portfolio
Compression Cycle;
(d) the Multilateral Portfolio
Compression Cycle was
(b) for each of the
Derivatives that was
modified, or terminated
and replaced—entry into
the Derivative was not a
Clearing Transaction that
was required to be Cleared
Through a Clearing Facility
in accordance with Rule
“the Clearing Transaction is
entered into by the Clearing
Entity as a result of the
Clearing Entity modifying or
terminating and replacing
Derivatives under a
Multilateral Portfolio
Compression Cycle;”
(c) the Clearing
Transactions entered
into by the Clearing
Entity as a result of the
Multilateral Portfolio
Compression Cycle are
only entered into with
persons who were
Multilateral Portfolio
Compression Cycle means a
process under which
portfolios of Derivatives
between participants in the
process are modified to
reduce their notional value or
terminated and replaced with
new Derivatives providing for
“conducted for the purposes
of reducing operational risk
or counterparty credit risk for
the participants. for reduced
notional exposures between
the participants, conducted
for the purposes of reducing
operational risk or
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conducted in accordance with
the rules of a third-party operator
of Multilateral Portfolio
Compression Cycles and
involved more than two
participants, none of which was
the operator;
(e) the Multilateral Portfolio
Compression Cycle was
conducted in compliance with the
counterparty credit risk tolerance
levels set by the participants in
the Multilateral Portfolio
Compression Cycle.
2.1.1 or sub-rule 2.1.6(2);
and
counterparties to those
Derivatives; and
reduced notional exposures
between the participants
counterparty credit risk for
the participants.”
Canada
(e) the multilateral portfolio
compression exercise is
conducted by an independent
third-party
(b) the existing derivatives
do not include a
mandatory clearable
derivative entered into
after the effective date on
which the class of
derivatives became a
mandatory clearable
derivative;
(c) the existing derivatives
were not cleared by a
clearing agency or clearing
house;
Multilateral portfolio
compression exemption in
National Instrument 94-101
and (a) the mandatory
clearable derivative is
entered into as a result of
more than 2 counterparties
changing or terminating and
replacing existing
derivatives;
(d) the mandatory
clearable derivative is
entered into by the same
counterparties as the
existing derivatives;
Hong
Kong
Exempted “if the transaction is
entered into by the person (i) as
a result of a multilateral portfolio
compression
cycle that meets the
requirements referred to in
subrule (2);
(2) The requirements are that
the multilateral portfolio
compression cycle—
(a) was conducted in
accordance with the rules of an
operator of multilateral portfolio
compression cycles;
(b) involved more than 2
participants, none of which was
the operator of the cycle; and
(c) was conducted in compliance
with the counterparty credit risk
multilateral portfolio
compression cycle means
a process applied to
portfolios of OTC derivative
transactions.
b) the multilateral portfolio
compression cycle […] (ii)
involves more than 2
participants and the operator
cannot be a participant (i.e. a
bilateral compression will not
be able to benefit from the
exemption);
Exempted “if the
transaction is entered
into by the person […] (ii)
with a participant in the
multilateral portfolio
compression cycle that
was a counterparty to
one or more of the
compressed
transactions;”
Multilateral portfolio
compression cycle means a
process applied to portfolios
of OTC derivative
transactions between
participants in the process—
(a) under which some or all
of the transactions are
(i) modified to reduce their
notional value; or
(ii) terminated and replaced
with one or more new OTC
derivative transactions which
have the effect of reducing
exposures between or
among the participants;
Multilateral portfolio
compression cycle means a
process applied to portfolios
of OTC derivative
transactions between
participants in the process
[…]
(b) that is conducted for the
purposes of reducing
operational risk or
counterparty credit risk for
the participants.
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tolerance levels set by the
participants in the cycle.
Singapore
(d) that is conducted by an
operator engaged by parties to
derivatives contracts contained
in the portfolio;
and (f) that is conducted — (i) in
accordance with rules set by the
operator; and (ii) in compliance
with a counterparty credit risk
tolerance level set by all the
participants”.
(e) in which there are at least
3 participants;”
(b) if the derivatives
contract is entered into
[…] (ii) with a participant
in the portfolio
compression cycle that
was a party to one or
more of the compressed
derivatives contracts
under the cycle.
The definition of multilateral
portfolio compression cycle
means a process:
“(a) that is applied to a
portfolio of derivatives
contracts;
(b) under which some or all of
the derivatives contracts in
the portfolio are — (i)
modified to reduce their
notional amount; or (ii)
terminated and replaced with
one or more new derivatives
contracts which have the
effect of reducing notional
exposures between the
participants;
The definition of multilateral
portfolio compression cycle
means a process:
(c) that is conducted for the
purposes of reducing
counterparty risk or
operational risk for the
participants;