Alternative Investment Management Association
Patrick Pearson
Head of Financial Market Infrastructure
European Commission
Rue de Spa 2
1000 Brussels
By email: patrick.pearson@ec.europa.eu
3 November 2014
Dear Patrick,
EMIR: Concerns regarding the frontloading obligation
The Alternative Investment Management Association (“AIMA”; “we”) 1 are writing to express our concerns
regarding the approach set out in respect of frontloading by ESMA in its “Final Report: Draft Technical Standards
on the Clearing Obligation: Interest Rate OTC Derivatives” (“the Final Report)2.
While AIMA has been a consistent proponent of the move to central clearing, we feel that the approach set out by
ESMA involves undue operational complexity and will create significant legal uncertainties.3 In what follows, we
comment on the concept of frontloading and ESMA’s proposed categorisation of entities for the purposes of phasein of the clearing obligation. We also highlight potential solutions to deal with the problems we identify.
1. Frontloading: challenges associated with a retroactive clearing obligation
We have previously expressed concern regarding the potential impact of any frontloading obligation 4 and
therefore support the approach that ESMA has taken in respect of contracts entered into in Period A (between
notification of the classes to ESMA and the publication in the Official Journal of the regulatory technical standards
(RTS) on the clearing obligation), that effectively ensures that none of these contracts are subject to the clearing
obligation.
While we appreciate that ESMA has sought to come up with a balanced approach in respect of contracts entered
into in Period B (between publication in the Official Journal of the RTS and the date on which the clearing
obligation takes effect), whereby the circumstances in which new Category 3 entities (discussed below) would
have to frontload contracts are kept to a minimum, we remain of the view that any retroactive clearing obligation
will have a disruptive impact on the trading activities of Category 1 and 2 entities, as they would be forced to reprice and novate non-cleared bilateral transactions.
To avoid these issues, some market participants will almost certainly elect to start clearing such contracts ahead
of the clearing obligation taking effect (in order to avoid having to resubmit them to clearing when it does take
effect), which in effect negates the value of establishing a phase-in period for the obligation. Indeed, ESMA notes
that “frontloading may turn out to be a strong incentive for counterparties to start central clearing as soon as
possible to minimize the number of contracts subject to frontloading”.5
1
Founded in 1990, the Alternative Investment Management Association (AIMA) is the global representative of the hedge fund industry. We
represent all practitioners in the alternative investment management industry – including hedge fund managers, fund of hedge funds
managers, prime brokers, legal and accounting firms, investors, fund administrators and independent fund directors. Our membership is
corporate and comprises over 1,400 firms (with over 7,000 individual contacts) in more than 50 countries. AIMA’s manager members manage a
combined $1.5 trillion in assets (as of March 2014).
2
See http://www.esma.europa.eu/system/files/esma-2014-1184_final_report_clearing_obligation_irs.pdf
3
We note that other associations, including ISDA, have written to the European Commission to highlight similar concerns. We would like to
take this opportunity to highlight our endorsement of many of the substantive points raised in ISDA’s submission of 10 October 2014.
4
AIMA-MFA Response – The Clearing Obligation Under EMIR, 12 September 2013
5
The Final Report, p.32
The Alternative Investment Management Association Limited
167 Fleet Street, London, EC4A 2EA
Tel: +44 (0)20 7822 8380 Fax: +44 (0)20 7822 8381
E-mail: info@aima.org Internet: http://www.aima.org
Registered in England as a Company Limited by Guarantee, No. 4437037. VAT registration no: 577 5913 90. Registered Office as above
If, therefore, ESMA’s desire is to ensure an early move to central clearing, then it would make much greater sense
to adjust the phase-in periods associated with the categorization of counterparties, rather than seek to address
this in an indirect manner that will cause disruption and legal uncertainty (see discussion below).
It is also worth noting that third-country entities are likely to scale back the degree of their trading activity with
European counterparties in order to avoid the challenges associated with frontloading; this would be damaging to
European OTC derivatives markets, and would exacerbate the recent trend toward fragmentation of the global
OTC derivatives markets, arising as a result of insufficiently coordinated regulation. 6 On this point, we continue to
argue in favour of a comprehensive solution between the CFTC and European Commission regarding the scope of
their respective rules, addressing in particular the position of funds that are majority owned by US persons and
subject to CFTC requirements, even when the key nexus of their operations (including portfolio management and
trading relationships) is in the EU.
2. Categorisation of entities
In the Final Report, ESMA proposes the following framework, according to which entities would be classified for
the purposes of determining their clearing start date:

Category 1: Clearing members - begin clearing six months after the RTS enter into force.

Category 2: Financial Counterparties (FCs) and Alternative Investment Funds (AIFs) that are non-financial
counterparties above the clearing threshold (NFCs+), which are not included in Category 1, and which
belong to a group for which the aggregate month-end average notional amount of non-centrally cleared
derivatives for November 2014, December 2014 and January 2015 is above €8bn – begin clearing 12
months after the RTS enter into force.

Category 3: FCs and other NFC+ AIFs that have a low level of activity in uncleared derivatives and which
are not included in Category 1 or 2 - begin clearing 18 months after the RTS enter into force.

Category 4: Non-financial counterparties - begin clearing 3 years after the RTS enter into force.
In order for an AIF to determine whether it falls with Category 2 or Category 3, it will therefore need to:


identify which entities form part of its group for the purposes of the threshold; and
obtain necessary data from relevant group entities regarding their OTC derivatives positions.
In terms of identifying the entities that constitute a group, further guidance is also needed as to whether this
would encompass separate investment funds under the same asset manager or whether individual funds will be
assessed separately. Also, it is not clear what would be the treatment of a single fund with more than one
investment manager.
If the intention is that the threshold assessment encompass multiple funds managed by a single manager, then
experience from other contexts suggests that it will take time to develop systems that allow for effective
monitoring of such a threshold across multiple legal entities, something that could not be readily achieved within
the period of time that would be available to Category 1 and Category 2 entities.
Given these inherent complexities, we are not convinced that a threshold-based approach is desirable.
3. Conclusion
Given that the thresholds-based approach put forward by ESMA did not feature in ESMA’s Consultation Paper 7
preceding the Final Report, industry participants have not had an opportunity to comment on this framework, and
we believe that ESMA’s position has not therefore been properly informed by industry input on this occasion.
Undoubtedly the most straightforward means to address the problems associated with frontloading would be to
reduce significantly the scope of activity to which it might apply, by adjusting upward the minimum remaining
maturity test for contracts entered into during Period B.
6
7
See http://www2.isda.org/attachment/NjIzNw==/Cross%20Border%20Fragmentation%20-%20An%20Empirical%20Analysis.pdf
See http://www.esma.europa.eu/content/Final-report-ESMAs-draft-technical-standards-Clearing-Obligation-Interest-Rate-OTC-Derivativ
At the same time, we believe it would be helpful to revisit the categorisation of counterparties in order to
develop a structure that is less complex to apply in practice (i.e. one that does not rely on thresholds). If the
desire is to ensure prompt migration to central clearing, then it is appropriate to focus further on the phase-in
periods, rather than creating a more elaborate categorisation structure.
Yours sincerely,
Jiří Król
Deputy CEO
Head of Government and Regulatory Affairs
The Alternative Investment Management Association Limited