1: Overview
This Policy Statement (PS) contains the Bank of England’s (the Bank’s) final policy on the proposal to add Overnight Index Swaps (OIS) that reference TONA to the scope of contracts subject to the derivatives clearing obligation. This policy was set out in the consultation paper published in September titled ‘Derivatives clearing obligation – introduction of contracts referencing TONA: Amendment to BTS 2015/2205’ (the September CP).
The Bank’s final policy maintains the proposal in the September CP to add TONA OIS contracts with an original maturity between 7 days and 30 years to the clearing obligation. However, the Bank has amended the date on which this change will come into force from 6 December 2021 to 31 January 2022.
The Bank’s final policy has been implemented via amendments to Commission Delegated Regulation (EU) 2015/2205 of 6 August 2015 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 clearing obligation (hereafter Binding Technical Standards (BTS) 2015/2205).
This PS also provides the Bank’s feedback to the responses to the September CP.
The PS is relevant to financial and non-financial counterparties that are subject to the clearing obligation under European Market Infrastructure Regulation (EMIR), and to central counterparties (CCPs).
1.1: Background
In the September CP, the Bank proposed to introduce a clearing obligation for OIS that reference TONA in the onshored BTS 2015/2205. The Bank’s proposal was a consequence of anticipated changes in activity in JPY interest rate markets resulting from announcements made by the Japanese authorities ahead of the discontinuation of JPY Libor on 31 December 2021. In recognition of the interaction between the broader interest rate benchmark reform and the policy objective of the clearing obligation, the Bank set out two aims:
- to keep the level of OTC derivatives activity covered by the clearing obligation broadly unchanged; and
- to avoid undermining the transition away from JPY Libor to TONA.
In keeping with these aims, the Bank’s proposal was for the TONA OIS contract type in the clearing obligation to cover broadly the same range of maturities as the JPY Libor contracts it was due to replace. However, the minimum maturity of the TONA OIS contract type would be 7 days (as opposed to 28 days for the JPY Libor contracts) to reflect the differences in the types of transactions these contracts have historically been used in.
The date proposed in the September CP for when the addition of TONA OIS would come into force was selected to coincide with the date on which a number of CCPs are due to contractually convert outstanding JPY Libor contracts, and when JPY Libor contracts are due to be removed from the clearing obligation.footnote [1]
1.2: Summary of responses
The Bank received six responses to the CP. The responses were generally supportive of the proposal. There were a few alternative suggestions made in relation to the maturity range of the TONA OIS contract type and the date on which the change comes into effect. These responses are discussed in more detail in Section 2.
1.3: Changes to draft policy
Where the final rules differ from the draft in the September CP in a way which is, in the opinion of the Bank, significant, the Financial Services and Markets Act 2000 (FSMA)footnote [2] requires the Bank to publish details of the difference together with a cost benefit analysis.
There is one change to the draft policy consulted on in September that the Bank considers significant. The Bank has changed the date on which the addition of TONA OIS to the clearing obligation will come into force, from 6 December 2021 to 31 January 2022. Further information about this change, including the particular circumstances that make it significant, can be found in Section 2 and a cost benefit analysis in Section 3.
1.4: Implementation
The Bank is amending BTS 2015/2205 using the Bank’s powers under Article 5(2)(a) of EMIR and under Section 138P of FSMA.
The standards instrument in the Appendix has now been made. The instrument specifies the date on which the addition of contracts referencing TONA to the clearing obligation will come into force.
The policy set out in this PS has been designed in the context of the UK having left the European Union (EU) and the transition period having come to an end. Unless otherwise stated, any references to EU or EU-derived legislation refer to the version of that legislation which forms part of retained EU law.footnote [3]
1.5: Next steps
As noted in Section 2.4 of the policy statement published in September titled ‘Derivatives clearing obligation – modifications to reflect interest rate benchmark reform: Amendments to BTS 2015/2205’ (September PS), the Bank will continue to monitor developments in the USD interest rate derivatives market and, where possible, co-ordinate with the Commodity Futures Trading Commission on changes to our respective clearing obligations. The Bank expects to consult on changes to the clearing obligation relating to the contact types referencing USD Libor in 2022.
2: Feedback to responses
Before making any standards instruments, the Bank is required by FSMA to have regard to any representations made to them, and to publish an account, in general terms, of those representations and its response to them.footnote [4]
The Bank has considered the responses received to the CP. This chapter sets out the Bank’s feedback to those responses, and the final decisions.
2.1: Modification to the scope of the clearing obligation
The Bank proposed to modify the contract types subject to the clearing obligation by adding the contract type in the OIS class referencing TONA with an original maturity of 7 days to 30 years.
All respondents were supportive of the proposal to add the TONA OIS contract type to the clearing obligation. The majority of respondents were also supportive of the proposed maturity range of 7 days to 30 years for the TONA OIS contract type. However, one respondent suggested that the maximum maturity should be extended to 40 years, as TONA OIS contracts with a maturity up to 40 years are eligible for clearing at the two CCPs in which the majority of these contracts are cleared.
As noted in Section 1.1, one of the main aims of the Bank’s proposal in the September CP was to keep the level of OTC derivatives activity covered by the clearing obligation broadly unchanged. In line with this aim, the Bank proposed that the TONA OIS contract type being added to the clearing obligation would have broadly the same maturity range as the JPY Libor contract types it is replacing. This remains the Bank’s preferred approach.
The Bank will continue to keep the scope of the clearing obligation under review, including the appropriateness in the range of maturities for the contract types within the current scope.
2.2: Date of modification
The Bank proposed 6 December 2021 as the date on which the addition of TONA OIS to the clearing obligation would come into force. This date was selected to align with the date on which a number of CCPs are due to contractually convert JPY Libor contracts and remove JPY Libor from their lists of contracts eligible for clearing.
A number of respondents were supportive of the date proposed, recognising the benefits of aligning this date with CCPs’ contractual conversions and the Japanese Financial Services Agency’s plans with respect to their clearing obligation. However, two respondents suggested pushing back the date on which the TONA OIS contract type is added to the clearing obligation. They both cited concerns over the limited time available to complete their preparations, particularly between the publication of the Bank’s final policy and the change coming into force. These preparations include, they note, developing and testing the control framework, adapting reporting systems and ensuring staff are properly trained. They have indicated that completing these preparations close to year end adds further complexity and have therefore recommended an alternative modification date of end-Q1 2022.
The Bank acknowledges the short timeframe between the publication of this policy statement and 6 December 2021, within which firms would need to complete their preparations. Delaying the date on which the change comes into force would provide firms with more time to complete their preparations without, the Bank considers, posing a risk to UK financial stability. Therefore having considered the responses received to the September CP, and taking into account the particular circumstances of this modification, the Bank has decided to defer the date on which the TONA OIS contract type will be added to the clearing obligation to 31 January 2022. The new timeframe between the publication of this policy statement and the addition of TONA OIS to the clearing obligation is similar to the timeframe between the publication of the September PS and the removal of the JPY Libor contract types.
A cost benefit analysis of this change can be found in Section 3.
2.3: Responses out of scope of the CP proposal
One respondent requested that the Bank consider providing an exemption from the clearing obligation for near risk-free reference rate (RFR) swaps resulting from post-trade risk reduction (PTRR) services. They indicated that the clearing obligation could impair the ability of large dealer banks to make use of these risk management services. The respondent acknowledged that this was something mentioned in their response to the previous clearing obligation consultation paper published in May 2021.
As noted in the September PS, the question as to whether the PTRR services should be exempt from the clearing obligation was included in HM Treasury’s Wholesale Markets Review (WMR) published in July. Since the consultation period for the WMR closed in September, the Bank has been engaging with HM Treasury and the Financial Conduct Authority on this question. This question will be addressed separately to this policy statement.
3: Cost benefit analysis
As noted in Section 1, FSMA requires the Bank to publish a cost benefit analysis where the final rules differ from the draft in the CP in a way which is, in the opinion of the Bank, significant.
This section sets out the Bank’s cost benefit analysis of changing the date on which the TONA OIS contract type is added to clearing obligation from 6 December 2021 to 31 January 2022. As with the cost benefit analysis in the September CP, the Bank has not included quantitative estimates for the proposal as it does not anticipate the costs to firms will be material. The Bank considers that data collection to support quantitative analysis would not be proportionate as the substance of the proposal in the September CP will remain the same.
3.1: Affected firms and markets
The Bank’s final policy is relevant to financial and non-financial counterparties that are subject to the clearing obligation under EMIR, and to CCPs.
3.2: Benefits
The Bank recognises that it may be difficult for counterparties to finalise their preparations in order to comply with the addition of TONA OIS to the clearing obligation within a short timeframe. The Bank also recognises that for counterparties to finalise their preparations, there is dependence on the Bank publishing its final policy. The key benefit of deferring the modification date from 6 December to 31 January is to give counterparties more time to plan and implement the operational changes required to comply with the obligation. Deferring the date past year-end should ensure that counterparties face less pressure to complete these changes within a condensed timeframe and during a busy period of the year. This in turn will mean that they are able to complete their preparations more smoothly and to a higher standard, which should minimise the risk of errors occurring in the future. The Bank has used the responses received to the September CP as well as subsequent engagement with market participants to inform its judgement in this area.
3.3: Costs
The Bank does not anticipate that the change in the modification date will have material costs to the financial stability of the UK. The main risk to financial stability would arise if in the interim period between 6 December and 31 January large volumes of TONA OIS contracts were traded but not cleared. However, the Bank does not expect this to happen. In the absence of mandatory clearing, there are other regulatory incentives for counterparties to clear TONA OIS contracts, such as the EMIR margin requirements. The effectiveness of these incentives is supported by the Bank’s analysis of EMIR trade repository data, which shows that 82% of TONA OIS contracts were voluntarily cleared in October. The percentage of TONA OIS contracts that have been voluntarily cleared has remained broadly consistent before and after the publication of the September CP.
As highlighted in Section 1, one of the principal aims set out in the September CP was to keep the level of OTC derivatives activity covered by the clearing obligation broadly unchanged. The Bank acknowledges that there will be a decrease in the level of OTC derivatives activity covered by the clearing obligation between the removal of JPY Libor contracts on 6 December and the addition of TONA OIS on 31 January. However, this decrease will be temporary and, as noted above, the risks are not expected to be material given the current levels of voluntary clearing.
In line with the other principal aim set out in the September CP, the change in modification date is not expected to undermine the broader RFR transition. The discontinuation of the JPY Libor benchmark is still scheduled for 31 December 2021. CCPs’ plans to contractually convert JPY Libor contracts also remain in place for 6 December 2021, which marks a key checkpoint in the broader transition. Therefore, in the eventual absence of JPY Libor contracts, both in the clearing space and more broadly, the Banks expects counterparties to naturally migrate to contracts referencing TONA irrespective of the clearing obligation.
4: Appendix
Section 138S (1)(b) and 138S (2)(g).
For further information, please see Transitioning to post-exit rules and standards.
Section 138J(3) and 138J(4) read together with Section 138S of FSMA.