REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL on whether trades that directly result from post-trade risk reduction services should be exempted from the clearing obligation for OTC derivatives under EMIR
Date: 2021-04-12
Institutions: Directorate-General for Financial Stability, Financial Services and Capital Markets Union, European Commission
Subjects: European Securities and Markets Authority, financial derivative, financial legislation, financial risk, payment system, provision of services, service

EN 

  EN 

   EUROPEAN COMMISSION  Brussels, 12.4.2021  COM(2021) 172 final  REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL on whether trades that directly result from post-trade risk reduction services should be exempted from the clearing obligation for OTC derivatives under EMIR  
 
 
REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND 
THE COUNCNIL 

on whether trades that directly result from post-trade risk reduction services should be 
exempted from the clearing obligation for OTC derivatives under EMIR 

1.  Introduction 

Article  85(3)(c)  of  Regulation  (EU)  No 648/2012  on  OTC  derivatives,  central 
counterparties and trade repositories1 (EMIR) as amended by Regulation (EU) 2019/834 
(EMIR  REFIT) 2  mandates  the  Commission  to  report  to  Parliament  and  Council  on 
whether trades that directly result from post-trade risk reduction services (PTRR services), 
including portfolio compression, should be exempt from the clearing  obligation referred 
to in Article 4(1) of EMIR. The report should take into account the extent to which those 
services  mitigate  risk,  in  particular  counterparty  credit  risk  and  operational  risk,  the 
potential  for  circumvention  of  the  clearing  obligation  and  the  potential  disincentive  to 
central clearing. 

This  report  takes  into  account  input  received  from  a  report  by  the  European  Securities 
and  Markets  Authority  (ESMA),  responses  by  stakeholders  to  ESMA's  public 
consultation  and  discussions  with  stakeholders.  ESMA’s  report  was  adopted  on  10 
November 20203; it was prepared in cooperation with the European Systemic Risk Board 
(ESRB)4, and takes into account the results of a public consultation5. 

2.  What are post-trade risk reduction services? 

There is  no harmonised  or widespread definition of PTRR services. Nevertheless, there 
are some common features which would allow PTRR services to be described, in a non-
exhaustive  way,  as  procedures  or  mechanisms  by  which  counterparties  reduce  one  or 
more  types  of  risks  of  a  portfolio,  keeping  their  market  exposure  neutral  and  with  the 
intervention of a PTRR service provider as a third party. 

The  only  PTRR  service  defined  in  European  law  is  portfolio  compression,  which  is 
defined  as  a  “risk  reduction  service  in  which  two  or  more  counterparties  wholly  or 
partially  terminate  some  or  all  of  the  derivatives  submitted  by  those  counterparties  for 
inclusion  in  the  portfolio  compression  and  replace  the  terminated  derivatives  with 

1   OJ L 201, 27.7.2012, p. 1. 
2   OJ L 142, 28.5.2019, p. 42. 
3  

ESMA, Report to the European Commission, Report on post trade risk reduction services with regards to 
the clearing obligation (EMIR Article 85(3a)), 10 November 2020, ESMA70-156-3351, ESMA70-156-
3351 Final Report PTRR Services - Article 85(3a) of EMIR (europa.eu). 
ESRB, ESRB opinion on ESMA's report on post trade risk reduction services with regards to the clearing 
obligation (EMIR Article 85(3a)), 12 June 2020, ESRB opinion on ESMAs report on post trade risk 
reduction services with regards to the clearing obligation (europa.eu). 
ESMA, Consultation Paper, Report on post trade risk reduction services with regards to the clearing 
obligation (EMIR Article 85(3a)), 26 March 2020, ESMA70-151-2852, esma70-151-
2852_consultation_report_ptrr_services_-_article_853a_of_emir.pdf (europa.eu).  

4  

5  

1 

 
 
 
 
                                                           
another  derivative  whose  combined  notional  value  is  less  than  the  combined  notional 
value of the terminated derivatives”6.  

ESMA focused on two PTRR services: portfolio compression and portfolio rebalancing. 
ESMA summarises the main characteristics of them (see table below) in its report.  

Portfolio Compression 

Portfolio Rebalancing 

Main purpose 

Mechanism 

to 

principle 

In 
reduce 
notional  amount  outstanding 
of 
the 
and 
transactions 
thus, 
operational risk. 

number 
and, 

Wholly or partially terminate 
(eventually) 
trades 
replace 
terminated 
derivatives  with  new  trades 
often with reduced notional. 

and 
the 

Reduce  counterparty  credit 
risk. 

the 

trades 
risk  of 

to 
Injecting  new 
the 
reduce 
portfolio.  No 
trades  are 
terminated  and  replaced  and 
the  notional 
increased 
rather than decreased. 

is 

Underlying Portfolio 

Cleared 
portfolio. 

or 

uncleared 

Uncleared 
portfolios. 

or 

mixed 

Market neutrality 

executed 
Transactions 
applying 
symmetric 
tolerances to all participants. 

Market  neutrality  is  ensured 
by inserting equal amounts of 
buy and sell exposures. 

Based  on  ESMA  Report  to  the  European  Commission  on  post  trade  risk  reduction 
services  with  regards  to  the  clearing  obligation  (EMIR  Article  85(3a)),  10  November 
2020,  ESMA70-156-3351,  ESMA70-156-3351  Final  Report  PTRR  Services  -  Article 
85(3a) of EMIR (europa.eu), p. 14. 

This  raises  several  questions.  First,  the  descriptions  of  portfolio  compression  and 
portfolio  rebalancing  in  ESMA’s  report  are  broad  and  descriptive.  Any  potential 
exemption  would  however  have  to  be  carefully  framed.  It  is  further  unclear  how  they 
relate  to  the  definition  of  portfolio  compression  in  the  acquis.  Second,  although  PTRR 
services have been around for several years, they are still developing. Moreover, they are 
not used in isolation, but may be, and indeed often are, combined. It seems to be common 
practice,  for  example,  to  compress  OTC  derivatives  portfolios  following  portfolio 
rebalancing  exercises  and,  thus,  to  use  both  services  combined.  This  may  alter  the 
impacts, including those examined in this report. The bigger the risk tolerances that are 

6   Article 2(1)(47) of Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 

2014 on markets in financial instruments and amending Regulation (EU) No 648/2012, OJ L 173, 
12.6.2014, p. 84–148 

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applied in portfolio compression, the more that a typically risk neutral exercise changes 
its characteristics and could have portfolio rebalancing-like effects.  

3.  ESMA Report 

ESMA’s report focuses on portfolio compression and portfolio optimisation/rebalancing. 
It concludes that portfolio compression and portfolio optimisation/rebalancing are useful 
tools to manage risk in both cleared and uncleared portfolios.  

According to ESMA, current figures on compression do not provide a way to assess the 
extent  to  which  the  clearing  obligation  has  hampered  PTRR  services,  as  they  are 
undertaken in accordance with the existing regulatory requirements. ESMA considers that 
this implies that more complex trades are used in compression and rebalancing in order to 
avoid the clearing obligation.  

ESMA  concludes  further  that  exempting  certain  transactions  that  result  from  portfolio 
compression  and  rebalancing  exercises  would  help  to  increase  the  use  of  these  PTRR 
services and contribute to reducing risk. ESMA considers that such an exemption would 
allow  for  legacy  trades  to  be  more  easily  compressed,  could  increase  participation  in 
PTRR  services  of  counterparties  less  interested  in  participating  today  and  reduce  the 
complexity in the market by using simpler trades for rebalancing.  

ESMA considers that, in the absence of compelling evidence or reasoning to the contrary, 
the  positive  effects  outweigh,  inter  alia,  the  increased  operational  burden  on  market 
participants and regulators, and the increase in gross risk in the non-cleared netting sets 
(in case of portfolio rebalancing). ESMA further notes that the mere function of allowing 
PTRR transactions to be exempt from the clearing obligation when related to uncleared 
portfolios  of  transactions  would  not  reduce  the  amount  of  transactions  cleared  with  the 
CCP because those transactions would not exist otherwise. Indeed, according to ESMA, 
the risk in portfolios would currently be offset with the use of instruments not subject to 
the  clearing  obligation.  An  exemption  from  the  clearing  obligation  would  therefore,  in 
ESMA’s view, allow risk to be offset with standardised contracts which would otherwise 
fall under the clearing obligation and which are less risky than the instruments currently 
used. This would in turn reduce the risk of compressed or rebalanced uncleared portfolios.  

In order to avoid that such an exemption from the clearing obligation be misused, ESMA 
suggests a series  of requirements for the provision of PTRR services7 as  well as  certain 
conditions  to  benefit  from  the  exemption  from  the  clearing  obligation,  differentiating 
between conditions for portfolio compression on the one hand8 and portfolio rebalancing 

7  

8  

ESMA, Report to the European Commission, Report on post trade risk reduction services with regards to 
the clearing obligation (EMIR Article 85(3a)), 10 November 2020, ESMA70-156-3351, ESMA70-156-
3351 Final Report PTRR Services - Article 85(3a) of EMIR (europa.eu), chapter 8.1, para. 332. 
ESMA, Report to the European Commission, Report on post trade risk reduction services with regards to 
the clearing obligation (EMIR Article 85(3a)), 10 November 2020, ESMA70-156-3351, ESMA70-156-
3351 Final Report PTRR Services - Article 85(3a) of EMIR (europa.eu), chapter 8.2, para. 333 to 338. 
3 

 
 
                                                           
on  the  other  hand 9 .  The  suggested  exemption  is  therefore  narrower  for  portfolio 
compression,  where  the  exemption  from  the  clearing  obligation  should  only  apply  to 
PTRR  trades  directly  resulting  from  compressions  of  uncleared  transactions  (primarily 
legacy transactions, i.e. trades that are uncleared today but would technically be subject 
to  the  clearing  obligation  and  rebalancing  transactions).  In  the  case  of  portfolio 
rebalancing,  the  exemption  would  apply  more  broadly,  as  ESMA  proposes  exempting 
transactions  resulting  from  the  rebalancing  of  uncleared  portfolios  as  well  as  those 
resulting  from  mixed  portfolios  compounded  of  centrally  cleared  and  uncleared  trades. 
This broader application of the exemption would allow risk management across portfolios, 
impacting OTC derivatives which are already centrally cleared. 

4.  Commission’s assessment 

In  order  to  make  an  informed  decision  on  whether  any  trades  that  directly  result  from 
PTRR services should be exempt from the clearing obligation, Article 85(3)(c) of EMIR 
requires the Commission to take into account the three following aspects:  

a)  The extent to which PTRR services mitigate risk, in particular counterparty credit risk 

and operational risk;  

b)  The potential for circumvention of the clearing obligation if an exemption was to be 

granted;  

c)  The potential disincentive to central clearing if an exemption was to be granted.  

In  addition,  given  that  the  clearing  obligation  has  been  introduced  following  an 
international  commitment  of  the  G20  to  contribute  to  safer  and  more  resilient  markets, 
this report also considers the quantitative evidence on the benefits of PTRR services and 
on whether any new risks could be caused by introducing such an exemption.  

a.  Extent to which PTRR services mitigate risk, in particular counterparty credit 

risk and operational risk 

It  is  generally  understood  that  PTRR  services  aim  to  reduce  the  risk  in  the  overall 
portfolio  and  all  risk-reducing  transactions  must  reduce  the  bilateral  risk  in  the 
portfolio into which they are booked.  

First,  regarding  portfolio  compression,  ESMA  indicates  that  such  services  aim  to 
reduce  the  number  of  contracts,  the  gross  notional  or  some  other  measure  of  risk 
without  materially  affecting  the  market  risk  of  the  portfolio.  This  might  ultimately 
reduce systemic risks, by  reducing the number of trades, line items  and/or notional 
exposure  between  counterparties.  This  is  in  line  with  international  work,  e.g.  the 
International  Organisation  of  Securities  Commissions  (IOSCO)  describes  the 
outcome  of  compression  as,  “diminished  operational  risk  for  individual  market 

9  

ESMA, Report to the European Commission, Report on post trade risk reduction services with regards to 
the clearing obligation (EMIR Article 85(3a)), 10 November 2020, ESMA70-156-3351, ESMA70-156-
3351 Final Report PTRR Services - Article 85(3a) of EMIR (europa.eu), chapter 8.3, para. 339 to 347. 
4 

 
 
                                                           
participants which may, in  turn,  lessen systemic  risk and enhance overall financial 
market stability”10.  

The  role  of  portfolio  compression  is  acknowledged  in  EMIR.  Article  11(1)(b)  of 
EMIR  in  conjunction  with  Article  14  of  Commission  Delegated  Regulation 
149/201311   recognises that portfolio compression mitigates risk and mandates it for 
non-centrally  cleared  OTC  derivatives.  Recital  30  of  that  Delegated  Regulation 
further reads: "Portfolio compression may also be an efficient tool for risk mitigation 
purposes  depending  on  circumstances  such  as  the  size  of  the  portfolio  with  a 
counterparty, the maturity, purpose and degree of standardisation of OTC derivative 
contracts.  Financial  counterparties  and  non-financial  counterparties  that  have  a 
portfolio  of  OTC  derivative  contracts  not  cleared  by  a  CCP  above  the  level 
determined  in  this  Regulation  should  have  procedures  in  place  in  order  to  analyse 
the  possibility  to  use  portfolio  compression  that  would  allow  them  to  reduce  their 
counterparty credit risk."  

Second,  ESMA  indicates  that  portfolio  rebalancing  aims  to  reduce  the  imbalances 
within  portfolios  created  due  to  the  impossibility  of  netting  credit  exposures  of 
cleared  trades  against  bilateral  trades  across  different  asset  classes  that  are  not 
eligible for clearing. As such, portfolio rebalancing is based on new OTC derivatives 
being entered into to reduce counterparty risk by reducing a certain risk (i.e. interest 
rate  or  currency  risks)  identified  between  two  counterparties  without  changing  the 
trades in the underlying portfolio. Market participants view this as a way to reduce 
the  market  between 
systemic  risk  by  decreasing 
counterparties. 

the  overall  exposure 

in 

Nevertheless,  the  ability  of  both  these  services  to  reduce  risks  is  limited  in  some 
aspects. Rebalancing exercises would not necessarily reduce operational risks as the 
new OTC derivatives entered into (and allowed with an exemption to remain in the 
bilateral  sphere)  could  create  additional  operational  risks.  Furthermore,  even  when 
using plain vanilla OTC derivatives instead of more complex derivatives to replace 
or  amend  trades  in  a  portfolio  rebalancing  exercise  reduces  risk  in  the  uncleared 
space, that portion of OTC derivatives would not be managed by CCPs which could 
increase risk in the combined system. Indeed, if exempt from the clearing obligation, 
such  OTC  derivatives  would  not  profit  from  the  risk  management  that  central 
clearing  offers.  That  could  increase  overall  risk  in  the  centrally  cleared  and  in  the 
uncleared  space  combined  even  where  the  risk  in  the  uncleared  space  would  have 
been reduced to some extent by the rebalancing exercise.  

10   FR09/2015, 28 January 2015, p. 13, FR01/2015 Risk Mitigation Standards for Non-centrally Cleared OTC 

Derivatives (iosco.org). 

11   Commission Delegated Regulation (EU) No 149/2013 of 19 December 2012 supplementing Regulation 
(EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical 
standards on indirect clearing arrangements, the clearing obligation, the public register, access to a trading 
venue, non-financial counterparties, and risk mitigation techniques for OTC derivatives contracts not 
cleared by a CCP, OJ L 052, 23.2.2013, p. 11.  

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The data provided by ESMA illustrates the widespread use of portfolio compression 
and portfolio rebalancing among the industry. The report does not however quantify 
the risk mitigation (counterparty credit risk and operational risk) provided by those 
services.  The  assessment  is  based  on  a  thorough  theoretical  assessment  rather  than 
empirical  data  which  could  allow  a  more  holistic  analysis  and  identification  of 
potential shifts in risk. It should be recognised though that such an assessment is not 
easy  given  that  an  exemption  is  not  yet  in  place,  but  a  quantitative  assessment  of 
similar  exemptions  in  third-countries,  which  ESMA  refers  to  in  the  annex  to  its 
report could shed further light. While portfolio rebalancing mitigates risk within the 
rebalanced  portfolios  themselves,  the  overall  mitigation  of  risk  seems  difficult  to 
assess  when  taking  a  more  systemic  view.  While  ESMA  has  provided  a  sound 
theoretical analysis of the potential issues and provided some data on the use of these 
services,  it  is  not  (yet)  sufficiently  clear  that  the  advantages  of  exempting 
transactions  resulting  from  PTRR  services  from  the  clearing  obligation  outweigh 
potential risks. 

b.  Potential for circumvention of the clearing obligation  

Article 85(3)(c) of EMIR requires that the European Commission's report considers 
whether an exemption from the clearing obligation for PTRR services has a potential 
for circumvention of the clearing obligation.  

On the one hand, ESMA points out that PTRR services currently avoid the clearing 
obligation by ensuring that the resulting trades do not belong to a category of OTC 
derivative subject to the clearing obligation, e.g. more complicated swaptions instead 
of plain vanilla derivatives. Should such derivatives originating from PTRR services 
be exempt from the clearing obligation in the future, counterparties engaged in PTRR 
services  could  use  these  simpler  and  more  standardised  instruments.  ESMA 
considers it unlikely that such an exemption would lead to the circumvention of the 
clearing obligation, as such derivatives would have never been concluded without the 
exemption.  Only  the  exemption  would  make  it  possible  to  use  them  for  PTRR 
purposes  in  the  non-centrally  cleared  space.  ESMA  views  such  derivative 
transactions as merely "administrative". They would not be entered into for any other 
reason. According to ESMA, an exemption would not incentivise market participants 
to use this technique as a way to avoid  central  clearing as it would not affect  OTC 
derivatives under the clearing obligation resulting from ordinary trading activities.  

On  the  other  hand,  some  stakeholders  note  that  an  exemption  to  the  clearing 
obligation would open up significant possibilities for regulatory arbitrage and ‘clever’ 
trading to extract OTC derivatives currently in cleared portfolios and to bring them 
into the uncleared space. This could act as an incentive for the circumvention of the 
clearing obligation leading to more rather than less risk. 

To  avoid  any  such  circumvention  of  the  clearing  obligation,  ESMA  recommends 
developing  conditions  for  any  exemption  from  the  clearing  obligation.  Such 
conditions could limit any exemption to certain OTC derivatives, e.g. legacy trades, 

6 

 
 
or to certain PTRR services. ESMA also suggests introducing some requirements for 
PTRR services, e.g. they should be market risk neutral, reduce the bilateral risk in the 
portfolio  into  which  it  is  booked,  and  be  carried  out  by  an  independent  service 
provider. 

Although  the  requirements  for  and  conditions  to  the  exemption  from  the  clearing 
obligation  that  ESMA  proposes  might  limit  the  possibilities  of  using  such  an 
exemption  to  circumvent  the  clearing  obligation,  further  analysis  is  needed.  In 
particular,  the  idea  of  mixed  (centrally  cleared  and  uncleared)  OTC  derivatives 
portfolios  being  included  in  portfolio  rebalancing  services  benefitting  from  the 
exemption  from  the  clearing  obligation,  and  to  combine  PTRR  services  in  the 
uncleared space with transactions to shift risk to central clearing (see end of Section 
3) would alter the relationship between the centrally cleared and the uncleared space, 
and the fact that different risk mitigation tools should be used in the centrally cleared 
and the uncleared space. 

Further  analysis  of  the  possible  liquidity  shifts  from  the  centrally  cleared  to  the 
uncleared space should also be considered.  

c.  Potential disincentive to central clearing 

The market is split as to the potential disincentive to central clearing that may arise 
from  an  exemption  from  the  clearing  obligation  for  trades  resulting  from  PTRR 
services. ESMA concludes therefore that while there is no evidence that there would 
be a risk of disincentive of the clearing obligation this should be monitored carefully 
in order to ensure that if any risk were to materialise it could be addressed by further 
regulation and/or supervisory measures.  

Should the exemption from the clearing obligation represent a cheaper option in the 
future in terms of capital and margin costs to hedge trades in the bilateral space, this 
could  lead  to  a  disincentive  to  central  clearing.  In  such  circumstances,  to  clear 
bilateral only could be more economical viable in terms of capital and margin costs, 
the larger the netting set.  

Voluntary  central  clearing  shows  that  this  potential  disincentive  does  not  fully  fall 
away:  It  is  quite  evident  that  counterparties  that  could  centrally  clear  an  OTC 
derivative  but  choose  not  to  do  so,  make  that  choice  because  bilateral  clearing  is 
economically reasonable for them. Moreover, a possible reduction of liquidity would 
disincentivise participation in central clearing.  

The  impact  of  PTRR  services  in  terms  of  a  possible  disincentive  to  clearing  is 
inconclusive.  Taking  into  account  divergent  stakeholder  views  as  well  as  ESMA’s 
report, further analysis by ESMA would be beneficial, in particular on the impact on 
incentives to central clearing which are strengthened where there is more liquidity in 
the centrally cleared space.  

5.  Conclusion 

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In  EMIR,  the  co-legislators  opted  for  central  clearing  as  a  key  element  of  the  G20 
commitments  which  should  be  the  primary  risk  mitigation  tool  for  plain  vanilla  OTC 
derivatives  under  the  clearing  obligation.  Other,  not  as  far  reaching  risk  mitigation 
techniques  should  be  used  with  regard  to  other  OTC  derivatives  not  falling  under  the 
clearing  obligation.  Both,  central  clearing  and  PTRR  services  thrive  in  their  respective 
spaces.  Generally,  certain  OTC  derivatives  should  only  be  exempted  from  the  clearing 
obligation  where  the  risks  of  granting  such  an  exemption  are  smaller  than  the  risks  of 
keeping the situation as it is today.  

ESMA,  in  cooperation  with  the  ESRB,  has  undertaken  an  extensive  and  thorough 
analysis  of  PTRR  services.  Nevertheless,  there  remain  important  open  questions.  In 
particular,  some  of  the  aspects  of  the  report  require  further  quantitative  assessment  and 
analysis in order for the Commission to be able to make a more informed decision on any 
potential proposal for legislative change. 

In particular, the following issues need further consideration: 

-  The definition of PTRR services, e.g. how different types of PTRR could be defined 

more concretely; 

-  The possible interlinkages between PTRR services and the impact of their combined 

use on the aspects raised in this report; 

-  The materiality of the risk of the circumvention of the clearing obligation, especially 

possible market practices that could be used to conduct such a circumvention; 

-  Possible conditions limiting the risk of such misuse of a possible exemption from the 

clearing obligation; 

-  The incentives  to  centrally  clear taking into account  a possible exemption from  the 

clearing obligation; 

-  Evaluation of potential liquidity shifts from centrally cleared to uncleared space. 

Further  work  on  the  abovementioned  issues,  in  particular  on  the  definitions  of  PTRR 
services and to collect more quantitative evidence, would enable a more comprehensive 
and  well  rounded  assessment  of  the  issues,  which  could  feed  into  the  general  EMIR 
assessment  report,  which  should  be  submitted  to  the  European  Parliament  and  the 
Council by 18 June 202412. 

12   Article 85(1) of Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 

2012 on OTC derivatives, central counterparties and trade repositories 

8