The industry body representing participants in the over-the-counter (OTC) derivatives market, the International Swaps and Derivatives Association (ISDA), today released a classification letter, intended to enable counterparties to notify each other of their status for clearing.

The classification letter, which allows counterparties to bilaterally communicate their status by answering a series of questions, is geared towards meeting the regulatory obligations of the European Market Infrastructure Regulation (EMIR), due to come into force in 2016.

EMIR and Clearing

In essence, EMIR aims to improve the transparency of risk across OTC derivative markets, trades which are not executed on a regulated exchange and historically have not been cleared via a Central Clearing Counterparty. EMIR shifts practices towards of larger derivatives, specifically introducing:

• Reporting obligation for OTC derivatives;
• Clearing obligation for eligible OTC derivatives;
• Measures to reduce counterparty credit risk and operational risk for bilaterally cleared OTC derivatives;
• Common rules for central counterparties (CCPs) and for trade repositories; and
• Rules on the establishment of interoperability between CCPs.

Implementation

It’s important that derivatives users know and communicate their classification status to their counterparties in advance.

The ISDA EMIR Classification Letter provides a practical mechanism to further the regulatory agenda, allowing counterparties to determine their categorisation under the EMIR taxonomy, which in turn effects their regulatory obligations under EMIR. At this stage, the clearing categorisation component of the letter initially covers interest rate derivatives only.

David Geen, ISDA’s General Counsel, explains further: “The first clearing mandates in the European Union are expected to come into force in 2016, so it’s important that derivatives users know and communicate their classification status to their counterparties in advance. The ISDA EMIR Classification Letter allows each party to quickly and easily notify its counterparties on a bilateral basis.”

With the letter, ISDA may be seeking to ease the migraine inflicted by ever more complex regulatory reporting requirements, although sceptics may argue that it simply represents another tick-box.

The ISDA EMIR Classification Letter and accompanying Guidance Note are available .