At a glance: derivatives clearing, exchange-trading and collateral in Germany – Lexology

Types of transaction

Clearing transactions

What categories of equity derivatives transactions must be centrally cleared and what rules govern clearing?

The clearing obligation under Regulation (EU) 648/2012 on OTC derivatives, central counterparties and trade repositories (EMIR) requires that all OTC derivative contracts within scope are subject to mandatory clearing and must be cleared with a central counterparty (CCP) that is authorised under EMIR (or that is recognised under EMIR for non-EU CCPs). Currently, EMIR does not mandate the clearing of equity derivatives. The specific classes of products that are within the scope of the mandatory clearing obligation under EMIR are set out in the Annex to the EMIR Delegated Regulation and cover standardised and liquid products (including certain interest rate swaps and credit default swaps). While it is contemplated that equity derivative products will become clearable in the future, the equity derivatives market is already predominantly exchange-based. As a result, equity derivatives that remain traded OTC are generally bespoke products and, therefore, are unlikely to easily meet the standardisation and liquidity requirements for clearable products under EMIR.

Exchange-trading

What categories of equity derivatives must be exchange-traded and what rules govern trading?

In Germany, equity derivatives are currently not required to be traded on an exchange. Following the clearing obligation under EMIR, Directive 2014/65/EU (MiFID II) and Regulation (EU) No. 600/2014 (MiFIR) introduced a mandatory trading obligation for certain derivative transactions. Broadly, the trading obligation applies to a class of derivatives that is traded on at least one admissible trading venue and there is sufficient liquidity in the trading of such class of derivatives. The trading obligation does not currently apply to equity derivatives.

If, however, equity derivatives are traded on an exchange, the exchange rules governing the trading of these derivatives depend on the relevant market segment. On the regulated market, the admission to trading and the trading on the exchange are governed by the Exchange Act and the legal framework of the relevant derivatives exchange, which, in case of Eurex, include the Exchange Rules, the Trading Conditions and the Eurex Contract Specifications as well as the Clearing Conditions. In respect of non-regulated markets, the exchanges have set up terms and conditions governing the trading on these markets.

Collateral arrangements

Describe common collateral arrangements for listed, cleared and uncleared equity derivatives transactions.

Uncleared equity derivatives are subject to the bilateral collateral arrangements of the parties. Usually, parties collateralise their transactions under an ISDA collateral support annex or the equivalent German Master Agreement for Financial Derivative Transactions (DRV) collateral addendum or the DRV collateral addendum for variation margin for compliance with the margin requirements under EMIR. Any transaction will be valued and a shortfall or excess will be determined on a net basis. The parties are required to transfer relevant collateral to cover any shortfall or reduce any excess. Under the DRV collateral addenda, the collateral is transferred by way of an outright collateral transfer, allowing the collateral taker to reuse the collateral.

The collateral arrangements for cleared OTC derivatives and listed derivatives are set out in the legal framework of the relevant clearinghouse. The Clearing Conditions of the German central counterparty, Eurex Clearing AG, provide for two different margin methodologies that may be applied to a relevant liquidation group as well as different margin types depending on the relevant class of transactions. In general terms, both initial and variation margin must be posted.

Exchanging collateral

Must counterparties exchange collateral for some categories of equity derivatives transactions?

As regards OTC equity derivatives that are not cleared by a central counterparty, the general margin requirements under EMIR apply. Under EMIR, variation margin and, subject to a phase-in, also initial margin must be exchanged between financial counterparties (broadly, credit institutions, insurance undertakings, undertakings for the collective investment in transferable securities, alternative investment fund managers, etc) and between financial counterparties and counterparties that are above the clearing threshold (NFC+). This means that most of the non-financial counterparties (ie, corporates) are not subject to the margin requirements of EMIR. The initial margin requirement currently applies to financial counterparties and NFC+ that each have outstanding OTC derivatives trades in an aggregate volume of €750 billion, but this threshold will be reduced to €50 billion from 1 September 2021 and to €8 billion from September 2022 in accordance with the applicable phase-in timetable. Most derivatives transactions are in scope for the variation and initial margin obligations, although single stock equity options and index options remain out of scope for a transitional period ending on 4 January 2024.

For cleared OTC derivative transactions and listed derivatives margin requirements apply under the applicable clearing conditions. The Clearing Conditions of the German central counterparty, Eurex Clearing AG, provide for two different margin methodologies that may be applied to a relevant liquidation group as well as different margin types depending on the relevant class of transactions. In general terms, both initial and variation margin must be posted.