European Market Infrastructure Regulation
EMIR (the European Market Infrastructure Regulation) is a regulatory framework which advocates for all standardized OTC derivatives contracts to be cleared through a central counterparty (CCP) and reported to a trade repository (TR).
The EMIR regulatory clearing and reporting requirements apply to:
- Any EU entity that enters into a derivatives contract
- Any non-EU entity that enters into a derivatives contract with an EU counterparty
- Any non-EU entities that enter into an OTC contract that has a ‘direct, substantial and foreseeable’ impact within the EU.
It applies specifically to:
- Financial counterparties (FCs - such as EU-authorised banks, investment firms, funds and fund managers, insurance, pension schemes and spread betting firms) and non-financial counterparties (NFCs - any corporate or counterparty that is not involved in financial services) whose aggregate OTC derivatives positions exceed the clearing threshold (see below)
- Non-financial counterparties with aggregate OTC derivatives positions below the clearing threshold but who are subject to some reporting obligations and certain risk mitigation requirements.
EMIR’s Clearing Obligations and Thresholds
EMIR’s clearing obligation applies to all OTC derivatives contracts that reach a certain threshold, taking into account a rolling average position over 30 working days (excluding hedging transactions). It does not apply when the gross notional value of an entity’s position remains below the applicable threshold for 30 working days.
- €1 billion in gross notional value for OTC credit and equity derivatives;
- €3 billion in gross notional value for OTC interest rate and foreign exchange derivatives;
- €3 billion in gross notional value for commodity derivatives and other OTC derivatives not listed above.
By 15th March 2013, all FCs and NFCs must notify ESMA:
- If they have exceeded the clearing threshold
- To confirm any uncleared OTC contracts
- To start implementing EMIR’s risk mitigation techniques.
If a FC or NFC whose aggregate OTC derivatives positions exceed the clearing threshold enters into a contract which is subject to mandated clearing, it must be cleared through a CCP (Central Counterparty Clearing) that is either EU-authorised or EU-recognised (if established in a third country).
EMIR’s Reporting Obligation
By 16th August 2012, all derivative contracts entered into by both FCs and NFCs must be reported to an EU-authorised or EU-recognised (if established outside of the EU) trade repository. This includes both OTC and exchange-traded contracts. It is expected that reporting obligations for credit and interest rate derivatives will take effect from 1st July 2013 at the earliest. Reporting obligations for derivative contracts in all other asset classes is anticipated to take effect from 1st January 2014 at the earliest.
What Are the Risk Mitigation Obligations?
Risk mitigation requirements apply to all uncleared OTC derivatives transactions and includes:
- Timely confirmation (from 15th March 2013)
- Portfolio reconciliation (from 15th September 2013)
- Portfolio compression (from 15th September 2013)
- Dispute resolution processes and procedures (from 15th September 2013).
Additionally, financial counterparties and above-the-threshold non-financial counterparties are subject to:
- Daily valuation and mark to market or mark to model (dates still to be announced).
- Timely, accurate and appropriate segregated exchange of collateral (dates still to be announced).
EMIR Client & Counterparty Classification Requirements
Just like other new regulations (such as FATCA, Dodd-Frank, MiFID II), financial institutions need to classify all clients and counterparties to a contract to comply with EMIR’s clearing obligations. Client and counterparty classifications will determine if they are:
- a Financial Counterparty (FC)
- a Non-Financial Counterparty (NFC)
- a Non-Financial Counterparty that is over the clearing threshold (NFC+).
The first two classification types should not prove problematic in terms of identifying and classifying the client and/or counterparty correctly. However, the same can’t be said for the last classification – NFC+.
The problem here is that, while EMIR dictates a requirement for NFCs to notify competent authorities and ESMA when they, or any others in their group, have exceeded the threshold, there is absolutely no obligation to inform the marketplace of this status update. There is no obligation placed upon NFCs to ensure all trading partners classify it appropriately. Likewise, EMSA is under no obligation to share its NFC+ register. Furthermore, NFCs normally lack sophisticated internal monitoring systems, making it difficult for them to even know when they have exceeded the clearing thresholds for their organisation or any entity within their group.
Failure to correctly classify counterparties or clients may adversely impact ability to do business.
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