July 18, 2017
Patrick Pearson
Head of Unit, Financial Markets Infrastructure
European Commission
Rue de Spa 2
1000 Brussels
Re:

The EMIR Refit Proposal

Citadel LLC 1 (“Citadel”) appreciates the opportunity to provide comments to the European
Commission (the “Commission”) on the proposal to further refine and enhance the European
Market Infrastructure Regulation (the “EMIR Refit” proposal). 2
EMIR implements several of the G20 commitments to improve the safety, stability andtransparency of the OTC derivatives markets, including (a) central clearing, (b) transaction
reporting to trade repositories, and (c) margin requirements for uncleared OTC derivatives. These
reforms are essential for a market that was notoriously concentrated, opaque, interconnected, andunder-collateralized in the years preceding the financial crisis. However, many EMIR reforms
have only been gradually phased-in since its adoption in 2012. For example, while central clearing
is now required for the largest financial counterparties when transacting in certain interest rate andcredit derivatives, central clearing requirements for more than 90% of EU financial counterparties
have been deferred until June 2019. 3
As implementation of the EMIR reforms continues, we support efforts by the Commission tocomprehensively review progress thus far, with a view to simplifying requirements and eliminating
disproportionate costs where possible. However, at the same time, we agree with the Commissionthat is important to ensure that the policy objectives of the EMIR reforms, including mitigating
systemic risk and increasing market transparency, are not undermined by changes to the regulatory
framework. With these considerations in mind, we provide our feedback below on theCommission’s proposals regarding (i) amending the scope of counterparties subject to the clearing
1

Citadel is a global financial firm built around world-class talent, sound risk management, and innovative marketleading technology. For more than a quarter of a century, Citadel’s hedge funds and capital markets platforms havedelivered meaningful and measurable results to top-tier investors and clients around the world. Citadel operates inall major asset classes and financial markets, with offices in the world’s leading financial centers, including
Chicago, New York, San Francisco, Boston, London, Hong Kong, and Shanghai.

2

See https://ec.europa.eu/info/law/better-regulation/initiatives/com-2017-208_en.

3Both “Category 1” and “Category 2” entities are subject to the clearing obligation for certain interest rate
derivatives denominated in EUR, GBP, USD, or JPY. “Category 1” entities (and “Category 2” entities from 9
August 2017) are also subject to the clearing obligation for certain interest rate derivatives denominated in NOK,
PLN, and SEK, and for certain index credit derivatives. Category 1 entities are clearing members for at least one of
the relevant classes of derivatives subject to the clearing obligation. Category 2 entities are (a) financial
counterparties or (b) alternative investment funds that are classified as non-financial counterparties, in each case thatexceed the notional amount threshold of EUR 8 billion in uncleared OTC derivatives exposure. For the number offinancial counterparties in “Category 3”, see ESMA Consultation Paper on the Clearing Obligation for Financial
Counterparties with a Limited Volume of Activity (July 13, 2016), available at: https://www.esma.europa.eu/pressnews/consultations/consultation-clearing-obligation-financial-counterparties-limited-volume.

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obligation for OTC derivatives, and (ii) improving the quality of data that is reported to traderepositories. In particular, we believe it is critical that any proposal to narrow the scope of the EU
clearing obligation for OTC derivatives is carefully calibrated based on data analysis showing both(a) the amount of daily trading activity and (b) the number of financial counterparties that would
be eligible for the proposed exemption.
I. The Scope of the Clearing Obligation for OTC Derivatives
A central pillar of the G20 reforms is moving trading activity in standardized OTC derivatives
into central clearing. Central clearing of derivatives mitigates systemic risk and improves
conditions for all market participants by protecting customers and enhancing pricing, liquidity,
and transparency. The risk mitigation and customer protection benefits of central clearing go far
beyond introducing disciplined collateralization of trades, reforms that are also gradually being
phased-in for uncleared OTC derivatives. In particular, central clearing greatly simplifies anotherwise complex, interconnected web of bilateral counterparty credit exposures. It protects
market participants from the default of their trading counterparties, and safeguards customer
collateral, which is held at a CCP rather than on the balance sheet of trading counterparties. Openpositions are managed in accordance with risk management and default management frameworks
that must satisfy strict regulatory requirements relating to stress testing, model back testing, andavailable financial resources. CCPs also facilitate multilateral netting and compression, improve
collateral management and trade reconciliation, and increase transparency around end-of-day
pricing, all of which serve to reduce systemic risk.
Given these unique and superior risk mitigating benefits of central clearing, it is critical thatany proposal to narrow the scope of counterparties subject to the EU clearing obligation for OTC
derivatives is closely scrutinized. Data shows that, although the scope of instruments covered by
the EU clearing obligation is materially similar to the US, the EU significantly lags the US in termsof the percentage of trading activity in these instruments that is actually cleared. According to the
FSB, “the clearing rate for new interest swaps has reached 87% in the US, while the comparable
figure for the EU as a whole is 62%.” 4 For credit, the clearing rate for new index CDS is estimatedat 80% in the US, while the clearing rate for OTC credit derivatives is only 37% in the EU. 5
These statistics reflect the fact that the EU clearing obligation, as phased-in to date, applies tomany fewer market participants than the US clearing obligation, since many financial
counterparties are not yet required to clear in the EU. Implementing broad new exemptions fromthe EU clearing obligation for smaller financial counterparties risks making this divergencepermanent, as the US framework only contains a narrow exemption for credit institutions with lessthan $10 billion in assets (and does not exempt other types of financial counterparties, such as
investment funds, asset managers, and insurance companies). 6

4

See FSB Review of OTC derivatives market reforms: Effectiveness and broader effects of the reforms (June 29,2017) at page 12, available at: http://www.fsb.org/wp-content/uploads/P290617-1.pdf.

5

Id.

6

We note that the US framework also has a separate end-user exemption, but that only applies to non-financial
entities that are hedging or mitigating commercial risk.

2While the introduction of limited exemptions from the clearing obligation may be warranted
for proportionality reasons, any such exemptions should be carefully calibrated based on data
analysis showing both (a) the amount of new daily trading activity (or turnover) and (b) the numberof financial counterparties that would be eligible for the proposed exemption. This data analysis
is necessary to fully evaluate the impact of the proposal, as systemic risk can arise not only fromthe volume of new trading activity that remains uncleared, but equally from the number of bilateralcounterparty credit exposures that persist. While any single “small financial counterparty” isextremely unlikely to raise concerns from a systemic risk perspective in isolation, the sheer numberof bilateral counterparty credit exposures that persist can be a source of systemic risk when
considered in aggregate, something that the Commission has noted from the financial crisis. 7
Unfortunately, much of the data considered in the EMIR Refit proposal appears to be borrowed
from an ESMA analysis that utilized data from 2015, which is before the EU clearing obligation
went into effect. 8 This data fails to show how much ongoing daily trading activity would becovered by the proposed exemptions, an important omission given the difference in clearing rates
between the EU and US cited above. 9 In turn, the data does show that a large number of financial
counterparties may be eligible for the proposed exemptions, as for example, more than 5,000
entities are classified as “small financial counterparties” trading interest rate derivatives. 10
We urge the Commission to further refine the analysis by leveraging data from traderepositories and CCPs in order to obtain clarity on the amount of daily trading activity and thenumber of financial counterparties that would be eligible for any exemptions to the EU clearing
obligation. In the absence of more accurate data, we believe the Commission should adopt acautious approach when defining the scope of additional exemptions, and focus increased attention
on improving market participants’ access to clearing. Below we provide suggestions for adopting
a more cautious approach with respect to the proposed exemptions, along with further ideas for
improving customer access to clearing.
A. Limiting Permanent Exemptions to Very Small Financial Counterparties
With respect to the proposed exemptions from the EU clearing obligation for “small financial
counterparties” (“SFCs”), we support several aspects of the EMIR Refit proposal, including:7

See, e.g., Communication from the Commission on further changes to EMIR, available at:https://ec.europa.eu/info/sites/info/files/170504-emir-communication_en.pdf (“The financial crisis demonstrated thatthe lack of transparency in the derivatives sector and the complex interdependence between financial market
participants increased uncertainty in times of stress and posed risks to global financial stability”).
8

See Impact Assessment accompanying the EMIR Refit proposal at page 31, available at:https://ec.europa.eu/info/law/better-regulation/initiatives/com-2017-208_en.

9

We note that the ESMA data instead looked at outstanding notional amounts on a given date, which is a muchdifferent analysis. Please see our comment letter to ESMA explaining why we believe ESMA’s analysis
significantly understated the trading activity of smaller financial counterparties (available at:https://www.esma.europa.eu/press-news/consultations/consultation-clearing-obligation-financial-counterpartieslimited-volume).
10

See supra note 8.

3•Applying the clearing obligation in full to an SFC as long as it exceeds the relevant
threshold for at least one asset class. Once an SFC exceeds a single threshold, it will be
required to obtain access to clearing and enter into a clearing agreement, which it should
then be able to utilize for other types of OTC derivatives that must be cleared. We note
the Commission should clarify that, similar to how the clearing thresholds are applied to
non-financial counterparties, SFCs should calculate trading activity on a gross basis,including both cleared and uncleared OTC derivatives.

•

Expanding the financial counterparty definition to include alternative investment funds(“AIFs”) that are organized in the EU. 11 This will help ensure a level playing field forentities engaged in financial activities.

However, we believe the Commission should further refine the proposed exemptions to ensurethat they only apply to very small financial counterparties. This will help prevent the developmentof a bifurcated market for standardized OTC derivatives, which was a concern noted in theCommission’s impact assessment. 12 One example would be further calibrating how the proposed
exemptions apply to investment funds managed by the same investment manager. Applying therelevant thresholds to each fund individually does not accurately reflect the aggregate trading
activities of the investment manager. Experience with implementing the US clearing obligationshows that investment managers and their investment funds were able to successfully obtain accessto clearing. Modifications that would more accurately reflect the role of the investment manager
include (a) calculating the thresholds at the manager level, or (b) applying the clearing obligationin full to a group of funds of a given manager as long as one fund is independently subject to theclearing obligation. Otherwise, the proposed exemptions risk excluding a material amount of daily
trading activity and a large number of financial counterparties.
B. Shortening the Temporary Exemption for Pension Scheme Arrangements
EMIR Refit proposes to extend the temporary exemption from the EU clearing obligation forpension scheme arrangements by three years, with a possible further extension of another two
years. While we support a temporary extension in lieu of a permanent exemption, we areconcerned that the additional delay of up to five years is too long to properly incentivize theinvestment of resources necessary to develop a clearing solution for pension schemes. A shorter
implementation timeline provides the commercial rationale for CCPs, clearing members, andservice providers to invest in expanding their clearing offerings, given the increased clearing
activity that can be expected to occur in the near term.
C. Improving the Clearing Obligation Procedure
While the scope of the EU clearing obligation in terms of instruments covered is very similar
to the US clearing obligation, there is one notable exception. For credit derivatives, the EU
clearing obligation only includes one of the two major index groups - iTraxx and not CDX. This11

We note the current drafting in the EMIR Refit proposal should be clarified to avoid inadvertently capturing allalternative investment funds, regardless of domicile.
12

See supra note 8 at page 110.

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is because no European CCP was authorized to clear CDX at the time ESMA conducted its initialassessment of credit default swap indices. 13
LCH SA subsequently introduced clearing for certain CDX indices. However, due to issues
with the formal process for notifying ESMA of additional instruments cleared by EU CCPs, thisexpanded offering by LCH SA has only recently been reflected in the ESMA Public Register. 14
ESMA highlighted its concerns to the Commission regarding the current process for updating the
public register, 15 and we urge that this be addressed as part of EMIR Refit.
We do not believe, however, that any significant changes are required to how the classes of
OTC derivatives are defined for purposes of the EU clearing obligation. The productcharacteristics used to specify the classes of derivatives subject to the clearing obligation provide
the appropriate level of granularity and closely replicate those used by the CFTC for purposes ofdefining the US clearing obligation. 16 Increasing the level of granularity to include additional
contractual specifications would create opportunities for evasion.
D. Enhancing Access to Clearing
We strongly support efforts by policymakers and regulators to expand client access to clearing.
As such, we commend the Commission on proposing revisions to the leverage ratio that willrecognize the exposure reducing effect of client initial margin. Clearing members have indicatedthat this change should have a significant positive impact on their commercial metrics. 17
In addition, we support the proposed requirement that clearing members must provide clearing
services on fair, reasonable, and non-discriminatory (“FRAND”) commercial terms. FRAND
requirements have been used in a variety of contexts, such as licensing arrangements, to provide
appropriate constraints on the commercial terms imposed by firms that may have a dominantmarket position or a patent that is essential for broader use. 18 While we do not believe that thisrequirement should be interpreted to prohibit clearing members from taking into account firmspecific credit or risk considerations when negotiating clearing arrangements, requiring clearing
13

See ESMA Consultation Paper: Clearing Obligation under EMIR (no. 2) (July 11, 2014) at page 11, available at:https://www.esma.europa.eu/sites/default/files/library/2015/11/2014-800.pdf.

14

See Public Register for the Clearing Obligation under EMIR (last update June 1, 2017) at page 20, available at:https://www.esma.europa.eu/sites/default/files/library/public_register_for_the_clearing_obligation_under_emir.pdf.
15

See EMIR Review Report no.4 (August 13, 2015) at pages 13-14, available athttps://www.esma.europa.eu/sites/default/files/library/2015/11/esma-2015-1254__emir_review_report_no.4_on_other_issues.pdf.
16

See, e.g, “CFTC Announces that Mandatory Clearing for Category 2 Entities Begins Today” (June 10, 2013),
available at: http://www.cftc.gov/PressRoom/PressReleases/pr6607-13.
17See, e.g., “FIA Global requests segregated margin be excluded from Basel III Capital Requirements” (Nov. 20,
2014), available at: https://fia.org/articles/fia-global-requests-segregated-margin-be-excluded-basel-iii-capitalrequirements.
18

See, e.g., J. Gregory Sidak, The Meaning of FRAND, Part I: Royalties, 9 J. COMPETITION L. & ECON. 931,
(2013), available at http://www.criterioneconomics.com/meaning-of-frand-royalties-for-standard-essentialpatents.html.

5members to comply with core principles relating to fairness and non-discrimination is helpful inmitigating potential conflicts of interest. Given that the firms currently offering clearing services
for OTC derivatives are exclusively banks, it is important to consider that the commercial interestsof a bank’s trading business may not be aligned with those of its clearing business. In particular,
given the higher profit potential on uncleared trades, trading businesses may not be incentivized
to support an expansion of client clearing offerings. Imposing a FRAND requirement will help tomitigate these potential conflicts.
An additional step to mitigate these conflicts is to ensure that a firm’s clearing business isactually operating independently of its trading business. This requirement has been successfully
implemented in the US, with the CFTC specifically prohibiting bank trading personnel fromdirectly or indirectly attempting to influence clearing personnel regarding whether to offer clearing
services to a particular customer or the associated commercial terms. 19 We urge the Commission
to consider adopting similar requirements in order to remove potential impediments that are
impacting client access to clearing.
Finally, we note that providing broad permanent exemptions from the clearing obligation,
however well-intentioned, may do more harm than good by undermining efforts to improve client
access to clearing. By reducing anticipated growth in clearing volumes, broad permanent
exemptions may dis-incentivize CCPs, clearing members, and service providers from investing in
expanding their offerings.
II. Improving Data Quality in Trade Repositories
We strongly support efforts by policymakers and regulators to improve the efficiency andaccuracy of data reporting. Ensuring timely access to accurate and comprehensive data assists
with analyzing specific market events and trends, informing policy decisions, and improving
general monitoring and surveillance. Therefore, we commend the Commission for proposingchanges to streamline the EMIR reporting rules, including designating CCPs as responsible forreporting exchange-traded futures transactions and reducing the reporting burdens for nonfinancial counterparties. In this regard, we urge the Commission to consider whether further steps
could be taken to streamline the reporting obligations of financial counterparties, such as bydesignating one counterparty as responsible for the reporting obligations.
We also support requiring trade repositories to have appropriate policies and procedures
relating to data quality, validation, and reconciliation. Therefore, we agree that trade repositories
should grant market participants access to data reported on their behalf in order to allow for a
verification of its accuracy. We note that, in the event a trade was executed anonymously, thisdata verification should not include any data that would identify the other counterparty. 20
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19

§23.605(d), 77 Fed. Reg. 20128 at 20211, available at:
http://www.cftc.gov/idc/groups/public/@lrfederalregister/documents/file/2012-5317a.pdf.
20

See the CFTC rule on “Swap Data Repositories - Access to SDR Data by Market Participants”, 79 Fed. Reg.
16672, available at: http://www.cftc.gov/idc/groups/public/@lrfederalregister/documents/file/2014-06574a.pdf.

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We appreciate the opportunity to provide our comments to the Commission. Please feel free
to call the undersigned at +1 (646) 403-8235 with any questions regarding these comments.
Respectfully,/s/ Stephen John Berger
Managing Director, Government & Regulatory Policy

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