1. FRONT ARENA
WHITE PAPER SERIES
WHAT SHOULD YOU DO
ABOUT THE EUROPEAN
Head of product management, Front Arena,
in SunGard’s capital markets business
2. On March 28, 2012 the European Parliament voted through
the European Markets and Infrastructure Regulation (EMIR)
following months of negotiations between the European
Council and Commission. More lobbying from market
participants will take place behind the scenes before the
regulations are ﬁnalized but the Parliament vote is an
important milestone in Europe’s quest to reform the
over-the-counter (OTC) derivatives market.
Many of the actions taken by market participants so far have
focused on the obvious, the pragmatic and the sensible – in
other words, participants have so far done what they had to do
or what they have deemed to be good for their business.
But there will be much more activity in the coming months
despite the fact that the regulations have yet to be ﬁnalized.
Work will focus on the system changes, upgrades and
implementations needed to adapt to the new trading
environment that will result from EMIR and other likeminded regulations.
What is EMIR?
At the end of 2009, the G20 leaders expressed the need to
regulate the over-the-counter derivatives market:
All standardized OTC derivative contracts should be traded on
exchanges or electronic trading platforms, where appropriate,
and cleared through central counterparties by end-2012 at
the latest. OTC derivative contracts should be reported to trade
repositories. Non-centrally cleared contracts should be subject to
higher capital requirements.
The US regulators responded with parts of the Dodd-Frank
Act. Meanwhile the European Parliament drew up the
European Market Infrastructure Regulation (EMIR). However,
to call EMIR Europe’s version of Dodd-Frank would not be
wholly accurate as there are some notable differences.
EMIR’s main focus is on reporting and transparency for OTC
derivatives transactions to drive down credit risk.
The main thrust is that all OTC derivatives transactions should
be reported to a trade repository which will enable regulators
to access data on the various counterparties in the market that
are transacting away from exchanges or central counterparties
(CCP’s). This will require the involvement of several
supernational bodies to collate, store and provide this
information to the various national regulators. Like DoddFrank, CCPs will be used to standardize much of the clearing
of OTC derivatives.
However, for derivatives, the main variation is that EMIR does
not address execution where the use of CCPs is mandated. In
the US, any OTC derivatives that are centrally cleared will need
to be transacted on a swaps execution facility (SEF). The
European equivalent of that is an organized trading facility
(OTF) – where you can set up a regulated market. This will be
covered within MiFID II.
Even though it is smaller in scope than Dodd-Frank, we believe
that, in practise, EMIR will be harder to implement consistently
across the many nations in Europe.
4 What should you do about the European Market Infrastructure Regulation (EMIR)
3. What has already been decided?
What is controversial?
We have seen published drafts and are currently in the
lobbying phase of the legislation. What is already known is
that market participants will report to Triana for OTC interest
rate derivatives and to the DTCC for credit derivatives. But in
terms of central clearing, there are still things to be done. A
redraft is scheduled for July 31 and the ﬁnalized rules are due
to be implemented on November 31. This is an extremely
short timeline given both the magnitude of the proposed
changes and the controversy around them.
There are ﬁve things that are not yet clear and, consequently,
are open to controversy.
Interoperability: The wish to create a harmonized, panEuropean securities market has underlined all of the European
Union’s regulations in the last decade and EMIR is likely to
further intensify the push for interoperability between the
various CCPs and OTFs that will be established. This is the
strongest push for interoperability across European institutions.
Nevertheless, interoperability across the various EU markets
is a far more complex task than in the US market where there
is generally one national clearing body for each asset class
as opposed to the 40 or more operating in Europe for
This timeline does, however, signal the regulators’ resolve
and their intention not be overly swayed by the lobbying of
the various interested parties: investment banks, high
frequency traders and more long term investors. If the passage
of Dodd Frank is anything to go by, there are likely to be
exclusions and delays before EMIR is passed into practice.
If interoperability in Europe is going to be achieved, it will
require the market to decide on, for example, a single
messaging standard and a single contingency process if one
CCP should go down, enabling ﬁrms to move their assets to an
Even simply setting up a bilateral process for trading
derivatives requires legal agreements and new workﬂow and it
is no small task.
4. Thresholds: The threshold for centrally clearing OTC
derivatives, under which ﬁrms would not be required to use
CCPs, is an area of debate at present. The original threshold
was set at €50 million in exposures. However this has
subsequently been increased substantially to €8 billion. The
mandating of central clearing will be a considerable expense
to those ﬁrms those ﬁrms that are larger than the stated
threshold. New software will be required, more paperwork will
be generated and new workﬂow will be needed to ensure
central clearing operates smoothly.
Moving of the threshold has led to further lobbying and ‘noise’
before the regulations are ﬁnalized, especially from buy-side
ﬁrms or non-ﬁnancial institutions that still remain above the
threshold. A compromise is likely to materialize that enables
these participants to use a sell-side counterpart to centrally
clear on their behalf, therefore saving on the considerable cost
of establishing their own central clearing capability.
The US and Dodd-Frank: Any market participant with trading
interests in the US will have to comply with Dodd-Frank and
execute on SEFs for any US-based OTC derivative transactions
so for these ﬁrms there is already a process underway. But
Dodd-Frank is a more onerous mandate for ﬁrms, creating an
extra burden for ﬁrms with a US interest as opposed to those
solely focused on European business. This creates an extra
burden as EMIR progresses to ensure that the two regulations
are at least compatible.
Margins: Margin calculations for many OTC derivatives is an
opaque process. It is difﬁcult to price the risk in a closed form,
there are numerous variations and margins are not dictated by
the regulations so there is no easy consistency between the
various margins. This leads to acceptance of complex
calculations by participants or the expense of matching those
calculations to the best of a ﬁrm’s abilities.
More established clearing houses are generally able to offer a
service for netting margins between exchange-traded and OTC
derivatives. This puts them at a signiﬁcant advantage as running
VaR calculations across larger portfolios can reduce margin. For
participants this is an even harder calculation.
The cost of margin and the cost of checking margins are
added expense to doing business in these derivatives, making
them more expensive (and thus less attractive) to those who
have a genuine hedging need to use them.
FX transactions: For the record, central clearing for FX
transactions was originally considered for inclusion within EMIR
but has subsequently been excluded due to the high volume
of transactions that would be involved and the existing
effectiveness of Continuous Linked Settlement (CLS) as a
means to lessen settlement risk.
6 What should you do about the European Market Infrastructure Regulation (EMIR)
5. How has the market responded?
What answers does Front Arena provide in this
Market participants are spending money on EMIR-related
activity despite the fact that the regulations have not been
ﬁnalized. The vast majority of the market is doing what is
obvious (such as reporting) and what is good for their
business (dealing with Dodd-Frank for any US counterparties
or divisions). It is one thing to have the necessary paperwork
in order to pursue compliance, however there are more
proactive steps that can be taken to achieve some
For example, broker dealers can set up enhanced APIs to
their clients that are fully stress-tested to receive entire
counterparties positions from another clearer; clearers can
set themselves up to be CCPs in the new world; dealers can
apply for single-dealer SEF/OTF status and start to build their
own approved OTFs.
As we have already observed, there are essentially three
areas that any derivatives dealing platforms must address
under EMIR and MiFID II (and Dodd-Frank): electronic
trading, central and bilateral clearing and reporting.
SunGard Front Arena is an OTC derivatives trading and
clearing platform that has always had electronic market
making in swaps and derivatives and a bilateral clearing
capability. It has also gone beyond these and now provides
direct connections and workﬂows for electronic swap and
derivatives transactions and effective workﬂow for both
bilateral and central clearing.
Front Arena is an OTC derivatives trading and clearing
platform that is ready to provide whatever the ﬁnal
regulations will bring.
Whatever happens, participants do need to adapt to the new
world where there will be electronic transaction venues for
OTC derivatives. Whether quote-driven exchanges like
venues or request-for-quote-driven automated broker venues
have the necessary connections will be vital for participation.
Some providers have already developed services for this task
and the connectivity issue in general offers great commercial
incentives to trading system providers.
ABOUT THE AUTHOR
Tim Dodd has been head of product management for SunGard’s
Front Arena for the last ﬁve years. He has extensive experience in
trading and risk management as well as software design, product
management and customer services. Starting with SunGard more
than twelve years ago, he initially held the position of head of
professional services in London with responsibility for Europeanwide project management for SunGard’s Panorama. He then became
product manager for equities, followed by Panorama and Adaptiv
Trading before being put in charge of Front Arena product strategy.
Tim’s diverse background gives him a deep understanding of the
needs of trading organizations, and an appreciation for the
complexities of cross-asset trading from front-ofﬁce through risk
management to operations.
Tim would value any feedback at firstname.lastname@example.org.