The European Commission has adopted a new set of rules that requires certain over-the-counter credit derivative contracts to be cleared through central counterparties. The March 1 decision, a Delegated Regulation, implements the clearing obligation under the European Market Infrastructure Regulation for credit default swaps.

“[The] decision marks another step towards making good on our G20 commitments to bolster financial stability, reduce risks and boost market confidence," EU Commissioner Jonathan Hill said in a statement.

Recent financial crises have highlighted that these risks are not sufficiently mitigated in the over-the-counter part of the market, especially in regards to credit default swaps. CCPs clear the transactions between two parties, helping to manage the risk that can arise if one party defaults on its payments. Financial markets become more stable and less risky by making it necessary for some classes of credit derivative contracts, or credit default swaps, to be cleared through CCPs, the announcement says.

At the 2009 Pittsburgh meeting, G20 leaders agreed that standardised OTC derivative contracts should be centrally cleared through CCPs.  In response, EMIR mandates the European Securities and Markets Authority to review clearing eligible contracts and, with the overarching aim of reducing systemic risk, to propose clearing requirements for products meeting certain criteria.

The new regulation specifically refers in to certain credit default swaps that are denominated in Euro covering some European corporates. By requiring these swaps to be cleared through CCPs, “financial markets become more stable and less risky,” a statement says, adding, “this creates an environment that is more conducive to investment and economic growth in the EU.”

This clearing obligation will enter into force subject to scrutiny by the European Parliament and the Council of the EU. It will be phased in over three years to give extra time for smaller market participants to comply.

This is the second clearing obligation that has been proposed by ESMA and it is expected that ESMA will propose obligations for other types of OTC derivative contracts in the near future. The first clearing obligation on OTC interest rate swaps was adopted in August, effective in December 2015.

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