Derivatives clearing obligation – modifications to reflect USD interest rate benchmark reform: Amendment to BTS 2015/2205

Published on 24 August 2022

1: Overview

This Policy Statement (PS) contains the Bank of England’s (the Bank’s) final policy on the proposal to add overnight index swaps (OIS) that reference the Secured Overnight Funding Rate (SOFR) to the scope of contracts subject to the derivatives clearing obligation (DCO) and to remove contracts referencing USD Libor. This Bank’s proposed policy was set out in the consultation paper published on 9 June 2022 titled ‘Derivatives clearing obligation – modifications to reflect USD interest rate benchmark reform: Amendments to BTS 2015/2205’ (the June CP).

The Bank’s final policy maintains the proposal in the June CP to add SOFR OIS contracts with an original maturity between 7 days and 50 years to the DCO from 31 October 2022 and to subsequently remove contracts referencing USD Libor. In the June CP, we proposed to align the date on which USD Libor contracts will be removed from the DCO with central counterparties’ (CCPs) contractual conversions of those contracts (which we anticipated would occur in Spring 2023). Consistent with that proposal, contracts referencing USD Libor will be removed from the DCO on 24 April 2023.

The Bank’s final policy has been implemented via amendments to Commission Delegated Regulation (EU) 2015/2205 of 6 August 2015 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council on over-the-counter (OTC) derivatives, central counterparties and trade repositories with regard to regulatory technical standards on the clearing obligation (hereafter Binding Technical Standards (BTS) 2015/2205).

This PS also provides the Bank’s feedback to the responses to the June CP.

The PS is relevant to financial and non-financial counterparties that are subject to the DCO under the on-shored European Market Infrastructure Regulation (EMIR), and to CCPs.

1.1: Background

In the June CP, the Bank proposed to introduce a clearing obligation for OIS that reference SOFR in the on shored BTS 2015/2205 from 31 October 2022 and to remove from the DCO contracts referencing USD Libor from around the date of CCPs’ contractual conversions of those contracts (which we anticipated would occur in Spring 2023). The Bank’s proposal was a consequence of the substantial increase in the volume and liquidity of SOFR OIS contracts traded since the beginning of 2022. In recognition of the interaction between the broader interest rate benchmark reform and the policy objective of the DCO, the Bank set out two aims:

to keep the level of OTC derivatives activity covered by the DCO broadly unchanged; and
to avoid undermining the transition to nearly Risk-Free Rates (RFRs).

In keeping with these aims, the Bank’s proposal was for the SOFR OIS contract type in the DCO to cover broadly the same range of maturities as the USD Libor contracts it was due to replace. However, the minimum maturity of the SOFR OIS contract type was proposed to be 7 days (as opposed to 28 days for the USD Libor contracts) to reflect the differences in the types of transactions these contracts have historically been used in.

In the June CP, the Bank proposed to align the date for the removal of contracts referencing USD Libor from the DCO with the date on which CCPs would contractually convert outstanding USD Libor contracts, which was expected to occur in Spring 2023. Since the publication of the June CP, a number of CCPs have firmed up their plans for those contractual conversions. In particular, LCH Ltd has confirmed it expects to convert such contracts over two weekends: 22–23 April 2023 and 20–21 May 2023;^{footnote [1]} while CME Group is consulting on its proposal to do so over the weekend of 20–21 May 2023.^{footnote [2]}

1.2: Summary of responses

The Bank received four responses to the CP. The responses were generally supportive of the proposals to add SOFR OIS referencing contracts to the DCO on 31 October 2022 and to align the removal of USD Libor referencing contracts with the contractual conversion by CCPs in Spring 2023. One respondent proposed an earlier date for the removal of USD Libor but also supported the option of alignment with the first conversion weekend by a major CCP. These responses are discussed in more detail in Section 2.

1.3: Changes to draft policy

Where the final rules differ from the draft in the June CP in a way which is, in the opinion of the Bank, significant, the Financial Services and Markets Act 2000 (FSMA)^{footnote [3]} requires the Bank to publish details of the difference together with a cost-benefit analysis.

The Bank will not be making any significant changes to the final rules that would require the requirements set out above to be met.

1.4: Implementation

The Bank amended BTS 2015/2205 using the Bank’s powers under Article 5(2)(a) of EMIR and under Section 138P and related provisions under Chapter 2A of FSMA.

The standards instrument in the appendix has now been made. The instrument includes specific dates on which each of the modifications to the DCO will come into force.

The policy set out in this PS has been designed in the context of the UK having left the European Union (EU) and the transition period having come to an end. Unless otherwise stated, any references to EU or EU-derived legislation refer to the version of that legislation which forms part of retained EU law.^{footnote [4]}

1.5: Next steps

This is the last of the planned amendments to the DCO in the light of the transition to RFRs. The Bank will continue to keep the wider DCO under review.

2: Responses to feedback on the CP

As part of the process for making any standards instruments, the Bank is required by FSMA to publically consult, have regard to any representations made to the Bank and to publish an account, in general terms, of those representations and the Bank’s response to them.^{footnote [5]}

The Bank has considered the feedback received on the CP. This section sets out the Bank’s responses to that feedback, and the final decisions.

2.1: Modification to the scope of the clearing obligation

The Bank proposed to modify the contract types subject to the DCO by adding the contract type in the OIS class referencing SOFR with an original maturity of 7 days to 50 years and removing the contract type referring USD Libor.

All respondents were supportive of the proposal to add the SOFR OIS contract type to the DCO and the removal of USD Libor. All the respondents were also supportive of the proposed maturity range of 7 days to 50 years for the SOFR OIS contract type.

2.2: Dates of modifications

The Bank proposed 31 October 2022 as the date on which the addition of SOFR OIS to the DCO would come into force. Respondents supported this date, although one noted that, while not an issue for itself, some market participants might find a notice period of less than three months challenging. The Bank concluded there was no need to change the date from its proposal.

Regarding the removal of USD Libor, respondents generally supported aligning the effective date with the contractual conversion by CCPs. One respondent proposed removing USD Libor on 6 March 2023, before any of the CCPs’ conversion dates, but also supported aligning the removal date with the first of the CCPs’ conversion dates.

As noted above in Section 1.1, some of the larger CCPs are undertaking their contractual conversions on multiple weekends. The Bank has decided to align the removal of USD Libor referencing contracts from the DCO with the first of those conversion dates, Monday 24 April 2023. To provide certainty to the market, this date will not change, irrespective of any potential changes to the CCPs’ contractual conversions announced subsequent to this PS.

2.3: Responses out of scope of the CP proposal

One respondent requested that the impact of a clearing obligation for OIS referencing SOFR on the Derivatives Trading Obligation (DTO) under MiFIR be kept in mind and analysed, noting concerns about potential negative impacts. The same respondent also requested confirmation as to whether transactions no longer subject to the DCO would be automatically removed from the scope of the DTO.

The DTO is a Financial Conduct Authority (FCA) competence under the UK Markets in Financial Instruments Regulation (UK MiFIR). The Bank has engaged with the FCA on the proposed changes to the DCO to ensure that timely changes can be made to the scope of the DTO, when appropriate. The FCA recognises the link between the DCO and DTO and will take necessary action to remove these instruments from the scope of the DTO, when they are excluded from the DCO. Further, the FCA continues to monitor liquidity and market developments in USD products and will consider in due course whether OIS referencing SOFR as a class of derivatives is sufficiently liquid for inclusion in the DTO and will consult separately on any proposed changes to the scope of the DTO. Any specific queries or comments in relation to the application of the DTO should be provided to the FCA directly.