Derivatives clearing obligation – modifications to reflect interest rate benchmark reform: Amendments to BTS 2015/2205

Published on 29 September 2021

1. Overview

This Policy Statement (PS) contains the Bank of England’s (the Bank’s) final policy on the proposal to modify the scope of contracts subject to the derivatives clearing obligation, which was set out in the consultation paper published in May titled ‘Derivatives clearing obligation – modifications to reflect interest rate benchmark reform: Amendments to BTS 2015/2205’ (the May CP).

The Bank’s final policy maintains the modifications proposed in the May CP. Specifically: to remove from the scope of the clearing obligation contracts referencing EONIA, JPY Libor and GBP Libor; add certain contracts referencing €STR; and extend the maturity of contracts referencing SONIA.

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 responses to feedback to the May CP.

The PS is relevant to financial and non-financial counterparties that are subject to the clearing obligation under EMIR, and to central counterparties (CCPs).

1.1. Background

In the May CP, the Bank proposed to modify the contract types which are subject to the clearing obligation in the onshored BTS 2015/2205 as a consequence of the anticipated changes in market activity resulting from interest rate benchmark reform. 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 EONIA/Libor to near risk-free reference rates (RFRs).

The basic premise of the Bank’s proposal was to remove contracts that reference benchmarks that are being discontinued and to replace them with Overnight Index Swaps (OIS), with the same range of maturities, which reference the replacement RFR benchmarks selected for each currency.

The changes proposed were limited to those relating to benchmarks that were already within the scope of the clearing obligation that were being discontinued by January 2022. Specifically:

to remove contracts referencing EONIA and replace them with contracts referencing €STR;
to remove contracts referencing GBP Libor and replace them with contracts referencing SONIA; and
to remove contracts referencing JPY Libor.

As the publication of the most widely used USD settings were to cease in June 2023, the Bank’s proposed changes did not relate to the transition from USD Libor at the time of publication.

Furthermore, as at the time of publication of the Bank’s CP there was uncertainty regarding which contract(s) referencing a replacement benchmark for JPY Libor would meet the criteria for being subject to the clearing obligation, the Bank’s proposed changes did not include any replacement contract(s) for those referencing JPY Libor.

The proposed dates for when each of the modifications to the clearing obligation would take effect were selected to coincide with key dates associated with the broader RFR transition. Specifically, the dates were selected to coincide with the contractual conversion of contracts referencing the benchmarks being discontinued by a number of CCPs. This activity is due to take place at different dates depending on the reference benchmark and hence the modifications to the scope of the clearing obligation are also due to come into force on different dates.

1.2. Summary of responses

The Bank received 16 responses to the CP from a broad spectrum of market participants. The responses were generally supportive of the proposal. A few responses suggested further amendments to BTS 2015/2205 that built on the draft policy under consultation. There were also a handful of responses that were outside the scope of the CP. 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 CP in a way which is, in the opinion of the Bank, significant, the Financial Services and Markets Act 2000 (FSMA)^{footnote [1]} requires the Bank to publish details of the difference together with a cost benefit analysis.

The Bank will not be making any significant changes to the final rules that would require the requirements set out above to be met.

There is however one change that will be made to BTS 2015/2205 that does not relate to the primary policy proposal in the CP and which is outlined in the section 2.7.

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 includes specific dates on which each of the modifications 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 [2]}

1.5. Next steps

In light of recent announcements by the Japanese authorities and the anticipated changes in market activity as a result of these announcements (see section 2.3), the Bank has today published a consultation paper alongside this PS, which proposes to introduce a clearing obligation for OIS that reference TONA, to come into force on or shortly after 6 December 2021.

The Bank expects to consult on changes to the clearing obligation relating to the contract types referencing USD Libor in 2022. Further information can be found in Section 2.4.

2. Feedback to responses

Before making any standards instruments, the Bank is required by FSMA to have regard to any representations made to it, and to publish an account, in general terms, of those representations and its response to them.^{footnote [3]}

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. GBP Libor to SONIA

The Bank proposed to remove the contract type referencing GBP Libor from the Basis Swaps, Fixed-to-float interest rate swaps and Forward Rate agreements classes and replace it with the contract type in the OIS class referencing SONIA but with an amended original maturity range of 7 days to 50 years.

All respondents were supportive of the proposal to remove the contract type referencing GBP Libor and amend the SONIA contract type to have a maturity range of 7 days to 50 years. The Bank will therefore maintain the draft policy as consulted on for the GBP Libor and SONIA contract types in the clearing obligation.

2.2 EONIA to €STR

The Bank proposed to remove the contract type referencing EONIA from the OIS class and replace it with the contract type in the OIS class referencing €STR with an original maturity range of 7 days to 3 years.

All respondents were supportive of the proposal to replace the contract type referencing EONIA from the OIS class with the contract type referencing €STR. The majority of respondents were also supportive of the proposed maturity range for the €STR contract type. However, three respondents suggested that the maturity range for the €STR contract type should instead be 7 days to 50 years. Their justification for this was that they expected activity in the €STR swap market would extend down the maturity curve compared to EONIA and therefore, having a broader maturity range would meet the criterion under Article 5(4)(b) EMIR.

As noted in section 1.1, one of the main aims of the Bank’s proposal in the 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 RFR contracts being added to the clearing obligation would have the same range of maturities as the contracts they are replacing. This remains the Bank’s preferred approach. Based on the direct relationship between EONIA and €STR, the liquidity in the former is expected to transfer to the latter as the transition progresses. Therefore given the limited liquidity in longer dated EONIA contracts and the fact that contract types referencing EURIBOR will remain within the scope of the clearing obligation (covering long maturities), there is little evidence to suggest that €STR contracts with long maturities will have sufficient liquidity in the near term to meet the criteria in Article 5(4) EMIR. The Bank notes that in the European Securities and Markets Authority’s (ESMA’s) July CP, like the Bank, they proposed to introduce a clearing obligation for €STR OIS contracts out to a maturity of 3 years.^{footnote [4]}

Having considered these responses, the Bank has decided to maintain the draft policy as consulted on for the EONIA and €STR contract types in the clearing obligation.

2.3. JPY Libor

The Bank proposed to remove the contract type referencing JPY Libor from the Basis Swaps and Fixed-to-Float interest rate swap classes, but not to introduce a replacement obligation at this time.

The large majority of respondents were supportive of the proposal to remove the contract type referencing JPY Libor from the clearing obligation. One respondent suggested that the contract type referencing JPY Libor should be replaced with the contract type referencing TONA in the OIS class, with a maturity range of 7 days to 40 years. They noted that since the CP was published, market liquidity had been migrating from JPY Libor contracts to contracts referencing TONA.

The Bank is aware of recent announcements by the Japanese authorities:

that market participants should cease the initiation of new transactions in JPY Libor swaps by no later than end September and that TONA will become the primary replacement RFR for JPY Libor in interest rate swaps;^{footnote [5]}
that liquidity providers have been recommended to change the quoting conventions from JPY Libor to TONA in the JPY interest rate swaps market as part of a ‘TONA first’ initiative;^{footnote [6]} and
the publication of a consultation paper by the Japanese Financial Services Agency (JFSA) on 8 September 2021, which sets out the JFSA’s proposed amendments to the Japanese clearing obligation.^{footnote [7]}

Analysis of EMIR trade repository data shows that since May, TONA OIS’s share of JPY denominated interest rate swaps in UK markets has grown from 6% to 40% in August 2021, with 76% being voluntarily cleared.

Having considered the above, the Bank has today published a consultation paper alongside this PS, which proposes to introduce a clearing obligation for TONA OIS, to come into force on or shortly after 6 December. Further information about this proposed amendment can be found in that CP.

2.4. USD Libor

The Bank did not propose any changes to the clearing obligation relating to the transition from USD Libor as part of the policy proposal in the CP. This was because the most widely used USD settings will cease in June 2023 (i.e. over a longer time horizon than the other benchmarks being discontinued).

The Bank did not receive any responses that questioned this approach or recommended alternative approaches for USD Libor.

The Bank is aware of recent announcements made by relevant authorities:

US authorities announced their support of a ‘SOFR first’ approach, which recommended 26 July 2021 for switching interdealer trading conventions for USD linear interest rate swaps from USD Libor to SOFR.^{footnote [8]}
the Bank and the Financial Conduct Authority (FCA) published a joint statement encouraging market participants to switch to SOFR in US dollar interest rate swap markets from 26 July 2021.^{footnote [9]}
the Commodity Futures Trading Commission’s (CFTC’s) Acting Chairman announced the intention for mandatory clearing of SOFR referencing swaps to be finalised in 2022.^{footnote [10]}

The Bank also notes that in ESMA’s July CP, ESMA requested feedback on removing contracts referencing USD Libor from the clearing obligation and introducing a clearing obligation for OIS contracts referencing SOFR in January 2022.

Analysis of EMIR trade repository data suggests that while there has been an increase in the use of SOFR OIS in UK markets, from 5% in May to 18% in August 2021 (with 91% voluntarily cleared), 82% of USD denominated interest rate swaps continue be transacted using USD Libor.

The Bank will continue to monitor developments in the USD interest rate derivatives market and, where possible, coordinate with the CFTC on changes to our respective clearing obligations. With this in mind, the Bank expects to consult on changes relating to the contract type referencing USD Libor in 2022.

2.5. Dates of modifications

The Bank proposed to align the dates for the modifications to the clearing obligation with the dates CCPs are expected to contractually convert outstanding contracts referencing the benchmarks being discontinued, and remove these benchmarks from the lists of contracts eligible for clearing.

The large majority of respondents were supportive of the proposed dates for the modifications to the clearing obligation. While there were a few alternative suggestions, the Bank considers the dates proposed in the consultation to best meet the two policy aims set out in the CP.

One respondent agreed with the Bank’s proposal to align the modification dates with CCPs’ dates but suggested considering a degree of flexibility to account for the possibility that CCPs change their plans for the conversion of contracts. The Bank considers it important to provide certainty to the market as to the dates on which the changes to the clearing obligation will be implemented. If the conversion of contracts take place at different dates to those expected, the Bank will consider whether any steps to mitigate the impacts resulting from this change are required.

Having considered the responses received relating to the modification dates in the CP, the Bank has decided to maintain the draft policy as consulted on for these dates.

2.6. Feedback out of scope of the CP proposal

A number of respondents put forward further suggestions to the CP that did not form part of the Bank’s main proposal. Notably:

four respondents requested that the Bank coordinate with the FCA to ensure that the clearing obligation and the derivatives trading obligation (DTO)^{footnote [11]} are broadly consistent, and to ensure that changes to one do not negatively affect the other.
one respondent expressed concerns about the automatic extension of the Bank’s proposal regarding the clearing obligation to the DTO, citing concerns about differences in equivalence decisions amongst jurisdictions and the complexities this poses for market participants. They suggested that the changes to the DTO should not be introduced as soon as is proposed for the changes to the clearing obligation.
six respondents suggested that the Bank continue its engagement with international jurisdictions to coordinate changes to our respective clearing obligations and to limit market fragmentation.
three respondents suggested that Post Trade Risk Reduction (PTRR) services be exempted from the clearing obligation. All of these respondents acknowledged HM Treasury’s Wholesale Markets Review wherein this topic is being explored.
one respondent requested clarification on whether existing approvals for intragroup exemptions remain valid or whether re-application is required for the proposed changes in the CP.

With respect to the first two points, the Bank has engaged with the FCA on the proposed changes to the clearing obligation and the implications of these changes for the DTO. On 14 July, the FCA published a consultation paper titled ‘Libor transition and the derivatives trading obligation’, which sets out the FCA’s proposed changes to the DTO in light of interest rate benchmark reform.^{footnote [12]} The changes proposed in the FCA’s consultation to the DTO are consistent with the Bank’s changes to the clearing obligation. The proposed effective dates of the FCA’s changes are also aligned to the dates on which the changes to the clearing obligation will take effect. The Bank notes that any specific queries or comments in relation to the FCA’s DTO proposal should be provided to the FCA directly.

In relation to the third point on international coordination, the Bank continues to engage with a number of authorities in international jurisdictions regarding their respective clearing obligations. It is important to note that given each jurisdiction has its own clearing obligation that is based on market activity in that jurisdiction, complete consistency may not always be possible. However, the Bank does not consider the differences observed thus far in the implementation of changes to each jurisdiction’s clearing obligation to give rise to any notable risks.

Concerning the responses on a PTRR exemption, as noted by the respondents, HM Treasury recently consulted on whether there would be a benefit in providing such an exemption to the clearing obligation as part of the Wholesale Markets Review published in July.^{footnote [13]} The Bank is engaging with HM Treasury on this work and the questions raised in the Review will be addressed separately to the Bank’s policy statement on modifications to the clearing obligation in light of interest rate benchmark reform.

On the final point listed above, the Bank notes that the FCA is responsible for managing the process for intragroup exemptions from clearing. These exemptions are granted on an entity pair basis. As set out on the FCA’s website,^{footnote [14]} there is no requirement for firms to re-apply for existing exemptions to accommodate for the new products brought within the scope of the clearing obligation. This is provided there has been no other change to the conditions under which the exemption was originally granted.

2.7. Frontloading requirement in BTS 2015/2205

In the May CP, the Bank highlighted that the draft standards instrument in the Appendix did not make specific reference to provisions of BTS 2015/2205 that had already been deleted or amended by other rules or regulations. This included Article 4 (Minimum remaining maturity) relating to the ‘frontloading requirement’ in EMIR that was previously deleted by Regulation (EU) 2019/834 of the European Parliament and of the Council of 20 May 2019, prior to the UK’s withdrawal from the EU. For the avoidance of confusion, the Bank has decided to insert a specific deletion of Article 4 in BTS 2015/2205 as can be seen in the final standards instrument in the Appendix. This change represents a technical adjustment to the BTS that does not impact its application.