CCPs (central counterparties) are a market infrastructure, which reduces systemic risk and enhances financial stability by standing between the two counterparties to a derivatives contract (i.e. acting as buyer to the seller and seller to the buyer of risk) and thereby reducing the risk for both.

Thereby, in a more general sense, they increasingly become the critical nodes in the financial system.

To satisfy requirements for mandatory clearing under the EU law the EU counterparties may use, as of 9 October 2017:

- 17 CCPs authorised in the EU (however, not all EU CCPs are authorised to clear all asset classes), as well as

- 32 third-country CCPs (TC CCPs) that have been recognised under the EMIR equivalency processes.

But, first, a few remarks on the nature and scale of the CCPs' business.

Communication from the European Commission "Responding to challenges for critical financial market infrastructures and further developing the Capital Markets Union" of 4 May 2017 (COM(2017) 225 final) said:

"Clearing derivatives transactions is a global financial service. As such, most clearing is done across borders, both within the EU and internationally with CCPs established in third countries. The scale and importance of CCPs in Europe and globally has nearly doubled since the post-crisis G20 commitment to clear standardised OTC derivatives through CCPs. On average 62% of their outstanding value was centrally cleared by CCPs across all types of derivative contracts. More specifically, the Bank for International Settlements estimated that the volume of cleared OTC transactions at the end of June 2016 amounted to $337 trillion globally, of which the large majority ($328 trillion) are interest rate derivatives."

Legal definition of the 'CCP' or 'central counterparty' is included in Article 2(1) of the European Market Infrastructure Regulation (EMIR). 

Pursuant to this provision CCP means a legal person that interposes itself between the counterparties to the contracts traded on one or more financial markets, becoming the buyer to every seller and the seller to every buyer.

The activity at issue is commonly known as "clearing", which is defined in the EMIR as "the process of establishing positions, including the calculation of net obligations, and ensuring that financial instruments, cash, or both, are available to secure the exposures arising from those positions".

Leave alone legal nomenclature and turn to practical business impacts. These are summarised in the concise manner in the ESMA's document "Risk Assessment on the temporary exclusion of exchange traded derivatives from Articles 35 and 36 of MiFIR of exchange traded derivatives from Articles 35 and 36 of MiFIR" (04 April 2016, ESMA/2016/461, p. 19), which unequivocally confirms:

"Trading and clearing costs are inextricably interlinked since the customer's choice of a trading venue is, among others, based on total costs, i.e. trading and clearing costs. If a trading venue can offer only competitive trading costs, but – due to the lack of access to a CCP providing competitive clearing costs and delivering margin netting benefits – no attractive clearing conditions, it may lose some of its business or exit the market."

The level playing field as regards the CCP's business is ensured in the MiFID II, which safeguards trading venues' rights to choose, which CCPs they connect to and vice versa.

MiFID II, moreover, requires trading venues and CCPs to provide access to each other on a non‑discriminatory basis.

There are reasonable grounds, then, for the market participants to be particularly interested in the CCP's legal framework, since it forms a  significant part of the overall competitive edge.

Authorised CCPs' list

Among first CCPs registered by ESMA under EMIR were:

- Nasdaq OMX Clearing AB, Sweden, date of authorisation - 18 March 2014,

- European Central Counterparty N.V. (EuroCCP - NL), Netherlands, date of authorisation - 1 April 2014,

- KDPW_CCP, Poland, date of authorisation - 8 April 2014.

Further CCPs authorised by ESMA (May 2014) were CC&G (Italy) and LCH.Clearnet SA (France) and LCH.Clearnet Ltd (UK) in June 2014.

The complete and actual list of central counterparties (CCPs) that have been authorised by ESMA to offer services and activities in the European Union in accordance with EMIR is available here.

CCPs' heterogeneity

CCPs are highly differentiated in terms of assets classes being cleared, including equities, bonds, energy, commodities, repos, clearing cash instruments and both exchange-traded and OTC derivatives.

The CCP's business is, however, not homogeneous - while a few CCPs offer clearing services in specific market segments, several EU CCPs are active in multiple asset classes.

Risk Assessment on the temporary exclusion of exchange traded derivatives from Articles 35 and 36 of MiFIR of exchange traded derivatives from Articles 35 and 36 of MiFIR, 04 April 2016, ESMA/2016/461 (p. 12) refers to six European CCPs which offer IRS clearing - although some of those CCPs have specialised on certain sets of currencies, the most liquid contracts can be cleared by up to five different CCPs. 

This is the case, for example, for OTC fixed-to-float swaps on Euribor.

The situation is different in the case of commodity derivatives: although there are five CCPs clearing this asset class, they have a higher degree of specialisation and little overlap in their product offering (hence there are few identical commodity derivatives contracts which are cleared by different CCPs).

Overview of product types cleared the CCPs in 2014 was presented by the Bank for International Settlements as follows:

Table: Percentage of CCPs offering clearing for a specific product type in 2014, by jurisdiction (Source: Central clearing: trends and current issues, Dietrich Domanski, Leonardo Gambacorta and Cristina Picillo, 6 December 2015, Bank for International Settlements)

Among the broad category of the CCP's are also the ones that act in the form of banks (although only three out of the many thousands of banks in Europe are licensed as CCPs).

CRR definition of the credit institution ("an undertaking the business of which is to take deposits or other repayable funds from the public and to grant credits for its own account") allows a whole range of activities that banks can exercise.

EBA and ESMA Report on the functioning of the Regulation (EU) No 575/2013 (CRR) with the related obligations under Regulation (EU) No 648/2012 (EMIR), ESAS-2017-82, 11 January 2017 underlines EMIR does not prevent the EU Member States from adopting an authorisation as a credit institution for CCPs established in their jurisdiction (Article 14(5)).

The said document also confirms that there are "many different models that are applied by banks and, not surprisingly, banks can indeed also be CCPs."

Also Article 23 and Recital 4 of the Commission Delegated Regulation (EU) 2016/2251 of 4 October 2016 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 for risk-mitigation techniques for OTC derivative contracts not cleared by a central counterparty literally refer to the CCPs being credit institutions.

Should a CCP also be licensed as a bank, the requirements of both the CRR and EMIR would, from a legal perspective, apply to the "bank-CCP".

CCPs' interconnectedness

CCPs are highly interconnected mainly due they clear common trading venues.

Some CCPs provide clearing on a cross-border basis to exchanges or other trading venues in Member States other than the Member State in which they are established.

Commission Staff Working of 13 June 2017 (SWD/2017/0246 final - 2017/0136 (COD), 13.06.2017, p. 23) provides an example of Eurex Clearing AG (established in Germany) which clears the Irish Stock Exchange, Börse Berlin is cleared by the LCH Ltd (established in the UK), LCH S.A (established in France), EuroCCP (established in the Netherlands) and SIX x-clear (established in Switzerland).

Participants on the London Stock Exchange are offered a choice of clearing services from LCH Ltd., EuroCCP and SIX x-clear for all traded instruments (except Polish and Spanish instruments, which are cleared by EuroCCP and LCH Ltd., and US instruments, which are cleared by EuroCCP).

European Commodity Clearing established in Germany clears commodity markets across the EU and elsewhere.

CCPs can be interconnected via so-called interoperability arrangements which allow clearing members of one CCP to clear transactions with clearing members of another CCP.

This is the case for EuroCCP, LCH Ltd. and SIX x-clear in various equities markets, for LCH S.A. and CC&G (established in Italy) in various bond markets and for LCH Ltd. and SIX x-clear in some markets for exchange traded derivatives.

In addition, KELER CCP (established in Hungary) is a clearing member of the European Commodity Clearing and offers access to clearing at ECC to its own clearing members.

The aforementioned Commission Staff Working of 13 June 2017 refers to the fact CCPs were originally designed to facilitate trading in securities and not as “macro- prudential institutions” with a responsibility to improve the safety and soundness of the broader financial system.

However, as the OTC derivatives market has grown and mandatory clearing of these instruments has become a feature of regulation, some CCPs have become sufficiently large and interconnected to be systemically important.

The economies of scale (due to netting and diversification benefits) attached to central clearing favour the use of a small number of large CCPs, resulting in a significant risk concentration in these infrastructures.

Equivalence regime

After these prolonged, preliminary remarks, let's go back to the issue of third-party CCPs and the aforementioned threats to their recognition in the EU.

It is useful to remind that for cross border issues, EMIR relies as regards CCPs on a system of equivalence decisions, combined with recognition decisions.

The European Commission in its communication of 30 October 2014 has recalled that a central counterparty established outside of the European Union (third-country CCP - TC-CCP) may provide clearing services to EU clearing members and trading venues where it has been recognised in accordance with the conditions set out in Article 25 of EMIR.

EMIR does not require the third country CCP to comply with the EMIR requirements for CCPs but instead relies on the CCPs to be fully compliant with their local regime and be effectively supervised domestically when the applicable CCP regime has been deemed equivalent (Final Report Draft regulatory technical standards on indirect clearing arrangements under EMIR and MiFIR, 26 May 2016, ESMA/2016/725, p. 5).

CCPs that have been recognised under the EMIR process will also obtain qualifying CCP (QCCP) status across the European Union under Regulation (EU) No 575/2013 (CRR). 

Finally, CCPs that have been recognised under the EMIR process may be used by EU counterparties in order to satisfy their mandatory clearing obligations under EU law.

A non-EU CCP wishing to obtain recognition must apply to the European Securities and Markets Authority (ESMA) and the conditions for recognition that must be checked are:

- the European Commission has adopted a positive equivalence decision with regard to the regulatory framework applicable to CCPs in the third country. This is the primary condition for recognition. The European Commission will assess the requirements applicable to CCPs in the third country. If the requirements achieve the same regulatory outcomes in terms of reduction of systemic risk, the European Commission may determine equivalence;

- the central counterparty in question is authorised and supervised in accordance with the regulatory framework determined to be equivalent under the above condition. ESMA will check this is the case when the CCP applies for recognition;

- the CCP is established or authorised in a third country that is considered as having equivalent systems for anti-money-laundering and combating the financing of terrorism to those of the Union in accordance with the criteria set out in the common understanding between Member States on third-country equivalence under Directive 2005/60/EC on the prevention of the use of the financial system for the purpose of money laundering and terrorist financing;

- cooperation arrangements have been established between the European Securities and Markets Authority - ESMA) and the relevant third country supervisory authorities covering supervisory arrangements and the sharing/notification of information.

ESMA initiates this part of the process with the relevant regulators of the CCP that has applied for recognition.

The first 'equivalence' decisions have been adopted by the European Commission on 30 October 2014 for the regulatory regimes of central counterparties (CCPs) in Australia, Hong Kong, Japan and Singapore (see the equivalence decisions).

The CCPs in these third country jurisdictions are able to obtain recognition in the EU, and can therefore be used by market participants to clear standardised OTC derivatives as required by EU legislation, whilst remaining subject solely to the regulation and supervision of their home jurisdiction. Although rules may differ in the detail, an outcome based approach is used.

In principle, the European Commission begins its assessment for equivalence if a CCP from a third country seeks recognition from the ESMA.

If a determination of equivalence is made, it will be given effect through a legally binding implementing act in accordance with Article 25(6) EMIR.

On 29 April 2015 the European Securities and Markets Authority (ESMA) has recognised ten third-country CCPs established in Australia, Hong Kong, Japan and Singapore.

In effect, on 7 May 2015 a list of recognised, equivalent third-country CCPs as well as of the classes of financial instruments covered by the recognition of the following CCPs has been published:

- ASX Clear (Futures) Pty Ltd,

- ASX Clear Pty Ltd,

- HKFE Clearing Corporation Limited,

- Hong Kong Securities Clearing Company Limited,

- OTC Clearing Hong Kong Limited,

- SEHK Options Clearing House Limited,

- Japan Securities Clearing Corporation,

- Tokyo Financial Exchange Inc,

- Singapore Exchange Derivatives Clearing Limited,

- Central Depository (Pte) Limited.

The recognition by ESMA allowed the abovementioned third country CCPs to provide clearing services to clearing members or trading venues established in the EU (emission derivatives were cleared by the two Australian CCPs: ASX Clear (Futures) Pty Ltd and ASX Clear Pty Ltd. (OTC bilateral and OTC third country exchange)).

The aforementioned European Commission communication of 30 October 2014 indicated that multiple further jurisdictions (United States including) were being assessed and were given a top priority.

Nevertheless, the prolonged process of the CCP's equivalence assessments has raised some tension (see Bourses urge EU to speed up rulings on clearing houses).

The opinion has been voiced that "delayed equivalence will increasingly have the effect of cutting off third-country clearing houses from European market participants", which threatens to "lead to a re-allocation of derivatives trading activity and liquidity away from markets that have not received equivalence determinations."

The risk of fragmentation of existing pools of liquidity in derivatives, that are traded and cleared on a cross-border basis, has also been accentuated.

On 13 November 2015 the European Commission determined that five further countries (Canada, Switzerland, South Africa, Mexico and the Republic of Korea) have the equivalent regulatory regimes for central counterparties as the European Union (see the relevant European Commissions' communication). 

The problem with the recognition of the US CCPs was stuck in the fact that the EU rules required CCPs to collect sufficient collateral to cover potential losses over a two-day horizon while the US only required enough collateral to cover potential losses over one day (Margin Period of Risk (MPOR)).

The shorter margin horizon under the US rules was balanced by the requirement for the US CCPs to collect sufficient collateral to cover the gross exposure of all clients, whereas the EU rules allowed for the netting of client collateral. 

Effects of this temporary stalemate are covered in greater detail under following links:

- New EU rate-swap rule will deal a big blow to US,

- U.S. derivatives chief urges EC to move fast on clearinghouse rules,

- European Commission and the United States Commodity Futures Commission: Common approach for transatlantic CCPs,

- The United States Commodity Futures Trading Commission and the European Commission: Common approach for transatlantic CCPs,

- ESMA resumes US CCP recognition process following EU-US agreement.

Finally, on 15 March 2016, the European Commission adopted an equivalence decision (implementing act) for the regulatory regime for CCPs of the United States Commodity Futures Trading Commission - see:

- Commission Implementing Decision (EU) 2016/377 of 15 March 2016 on the equivalence of the regulatory framework of the United States of America for central counterparties that are authorised and supervised by the Commodity Futures Trading Commission to the requirements of Regulation (EU) No 648/2012 of the European Parliament and of the Council, and

- the European Commission's press release of 15 March 2016, IP/16/807).

The said decision grants the US the equivalent regulatory regime for central counterparties as the European Union.

It is noteworthy, market infrastructure in the US jurisdiction is based on slightly different model of a CCP serving multiple trading venues.

The design where the Options Clearing Corporation (OCC) is the sole clearing organisation for all securities options exchanges in the US has the advantage that one single clearing pot allows the 13 option exchanges to offset their open interest in that pot against all correlated positions of the other member exchanges allowing for competition at the level of the exchanges (Risk Assessment on the temporary exclusion of exchange traded derivatives from Articles 35 and 36 of MiFIR of exchange traded derivatives from Articles 35 and 36 of MiFIR, 04 April 2016, ESMA/2016/461, p. 25).

Moreover, in 2012 OCC has been designated as a Systemically Important Financial Market Utility (SIFMU) by the Financial Stability Oversight Council (FSOC) as part of the Dodd-Frank financial overhaul law.

SIFMUs are entities whose failure or disruption could threaten the stability of the United States financial system and are subject to heightened oversight by the US financial regulator, such as expanded recovery and resolution plan requirements, and broader risk management requirements.

On 16 December 2016 the European Commission has determined that India, Brazil, New Zealand, Japan Commodities, United Arab Emirates (UAE) and Dubai International Financial Centre (DIFC) have equivalent regulatory regimes for central counterparties (CCPs) to the European Union (see the European Commission's Press release of 16 December 2016).

It is noteworthy, to facilitate the pertinent processes, on 17 March 2016 ESMA issued Practical Guidance for the recognition of third-country CCPs by ESMA (ESMA/2016/365). This document reads:

"According to Article 25(2) of EMIR, ESMA may only recognise a TC-CCP where certain conditions have been satisfied. In particular the European Commission needs to have adopted an implementing act determining, amongst other things, that the legal and supervisory arrangements of the jurisdiction in which the CCP is established are equivalent to the requirements laid down in EMIR (Article 25(2)(a) of EMIR) and the jurisdiction in which the TC-CCP is established needs to have equivalent systems for anti-money laundering and combating the financing of terrorism to those established in the European Union (Article 25(2)(d) of EMIR)" (p. 3).

In the said document ESMA strongly recommends that prior to submitting an application for recognition, potential applicants ascertain whether the conditions in Article 25(2) of EMIR are, or are likely to be, fulfilled.

This is important because if the conditions in Article 25(2) are not fulfilled then ESMA will not be able to grant the recognition, meaning that clearing members and trading venues established in the European Union will have to cease using the clearing services of the TC-CCP with immediate effect.

The ESMA's website covering comprehensive overview of the third country (non-EU) equivalence issues under EMIR can be accessed here.

The above website comprises, among others:

1. the list of recognised third-country CCPs, as well as

2. the list of CCPs established in non-EEA countries which have applied for recognition under Article 25 of EMIR.

However, the latter list is subject to some reservations, it includes only applicants who expressly agreed to have their name mentioned publicly, moreover, is not necessarily exhaustive and it remains subject to further updates.

Hence, as the ESMA explicitly states, the said list is provided for information purposes only and it is without prejudice to any future ESMA decision of the recognition of the applicant CCPs.

Applicants are required to indicate in their submissions for recognition as a TC-CCP under EMIR, whether they express their consent to being included in the said list to be published on ESMA's website.

As of January 2017 22 third-country CCPs were recognised and more were still awaiting for recognition following new equivalence decisions by the European Commission.

However, according to the opinion of Steven Maijoor, the Chair of the European Securities and Markets Authority, the EU should consider redesigning the equivalence approach because there are doubts whether ESMA has sufficient assurance that risks of the third country infrastructures' activities in the EU are adequately assessed and addressed by the home regulator in the third country, and ESMA has very limited opportunities to assess the specific risks that third country CCPs might be creating in the EU (PRIME Finance 6th Annual Conference, Keynote speech The Hague, 23 January 2017ESMA71-844457584-329 - see box below).

The ESMA's Letter of 27 January 2017 to the European Commission on the EMIR Review and ESMA sanctioning powers under EMIR and CRAR, ESMA70-708036281-1 argues in the same vein that considerations should also be given to the fact that in the current recognition process as defined in EMIR there is no provision that allows ESMA to deny recognition on the basis of any material risk emerging from its review of a CCP application, even though the fours conditions of Article 25(2) are met.

In the ESMA's view, in the case the current system is maintained, at a minimum, some key improvements recognition procedure should be envisaged:

- introduce a risk based assessment according to which recognition may be denied;


foresee that the review of recognition under article 25(5) with respect to the extension of activities and services in the European Union should be performed ex-ante and not ex-post;

- establish that the conditions (a) and (d) in Article 25(2) shall be met before a TC-CCP can submit an application;
reconsider whether for the assessment of the 4 conditions currently envisaged under EMIR, the wider consultation of many European and national authorities is valuable; and

- introduce recognition fees to cover for ESMA related costs and avoid that EU taxpayers finance the recognition costs of foreign infrastructures willing to offer services in the EU.

Further, let's take a look at some closer regulatory details regarding CCPs' framework.

Eligibility to become clearing member in the CCP

EMIR requires a CCP to be a designated system under Directive 98/26/EC of the European Parliament and of the Council of 19 May 1998 on settlement finality in payment and securities settlement systems.

This implies that clearing members of CCPs should qualify as participants within the meaning of that Directive, i.e. practically, they must be credit institutions, investment firms, or equivalent third country credit institutions or investment firms.

Legal effects of cleared derivative transactions not accepted for clearing by a CCP

Legal effects of cleared derivative transactions not accepted for clearing by a CCP depend on whether the transaction is concluded electronically on a trading venue or concluded through other means.

Cleared derivative transactions concluded electronically on a trading venue and not accepted for clearing by a CCP are void ("the trading venue shall void such contract" - Article 5(1) and Recital (10) of the Commission Delegated Regulation (EU) 2017/582 of 29 June 2016 supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council with regard to regulatory technical standards specifying the obligation to clear derivatives traded on regulated markets and timing of acceptance for clearing).

For other cleared derivatives transactions, the rules of the trading venue, and the contractual arrangements between the counterparties, should clarify in advance how these transactions are to be treated if not accepted for clearing by a CCP (Article 5(2) and Recital (11) of the said Commission Delegated Regulation (EU) 2017/582 of 29 June 2016).

The reason for above differentiation between is that the processing and submission for clearing to a CCP of the derivative transactions concluded electronically on a trading venue requires limited time, hence, the time for the market to move, and for the value and the risk of the cleared derivative transaction to change, in between the order and the non-acceptance is also very limited.

Therefore, the damage potentially suffered by counterparties whose transactions are not accepted for clearing by the CCP in this case - as opposite to transactions concluded through other means - is negligible.