Europ
pean Market Infra
astructure Regullation (“E
EMIR”) –
Current Status and Futu
ure Deve
elopmentts
D
Delegate Pack
P
14 May 20
015
Documen
nts
1.
EMIR: Presentation
2.
EMIR: An Ove
erview
3.
EMIR: The Pro
oposed Eu
uropean Re
egulation on
o Derivativves, Centrral
Counte
erparties an
nd Trade Repositorie
R
es
4.
EMIR: The Fin
nal Adopte d Regulato
ory Technical Standaards
5.
EMIR: Key Facts about M
Margining
6.
a its extrraterritorial applicability
EMIR: EMIR and
7.
CMS
S EMIR Te
eam
Further info
ormation, including
g a list of our offic
ces, can be foundd at www.cmsleg
gal.com
© CMS Cam
meron McKenna LLP
L
2015.
European Market Infrastructure Regulation (EMIR):
Current Status and Future Developments
Jason Harding
Eva Valentova
Agenda
1. Overview of EMIR
2. Who is in scope?
3. EMIR – implementation timeline
4. What is already live?
5. What is coming into force?
6. Expected developments
2
1. Overview of EMIR
 EU regulation concerning OTC derivatives, central counterparties and trade
repositories
 Adopted as a response to the G20 commitments made in 2009 following the
financial crisis and the AIG and Lehman collapses
 Effective as of 16 August 2012 in all member states, without the need for any
national legislation
 ‘Framework legislation’ – detailed implementing rules contained in regulatory
technical standards (RTS) developed by the European Securities & Markets
Authority (ESMA)
3
1. Overview of EMIR (cont.)
 EMIR imposes four main obligations on derivatives market counterparties in the
EU:
• Obligation on a non-financial counterparty to notify competent authority
immediately (= on the first day) if over ‘clearing threshold’
• Mandatory clearing of certain types of OTC derivatives via a central
counterparty (CCP)
• Implementation of risk mitigation techniques in relation to any OTC
derivatives that are not cleared, including arrangements for timely confirmation;
portfolio reconciliation, portfolio compression and dispute resolution; daily
valuation of outstanding OTC derivative contracts and margining
• Mandatory reporting of all derivatives (OTC and ETD) to a trade repository
(TR)
4
2. Who is in scope? – Entity types
 Financial counterparties (FCs): broadly, credit institutions, investment firms,
insurers/reinsurers, UCITS/UCITS managers, pension schemes, alternative
investments funds (AIFs) managed by AIFMs, in each case authorised or
registered in accordance with the relevant EU directive
 Non-financial counterparties (NFCs): all undertakings established in the EU
which are not FCs; NFCs whose OTC derivatives exceed certain ‘clearing
thresholds’ are referred to as NFC+
 Counterparties outside the EU (third country entities or TCEs): may be
subject to the clearing and risk mitigation obligations under EMIR
 Exempt: EU central banks, public bodies dealing with public debt and Bank for
International Settlements
5
2. Who is in scope? – Third country entities (TCEs)
 TCEs may be subject to the clearing and risk mitigation obligations under EMIR
 EMIR can affect TCEs directly and indirectly
 The direct effect of EMIR on TCEs is a consequence of the RTS on direct,
substantial and foreseeable effect of contracts within the Union and to prevent the
evasion of rules and obligations (Commission Delegated Regulation (EU) No
285/2014)
6
2. Who is in scope? – Extra-territoriality
 Art. 3 of EMIR (in force 10 April 2014)
• Covers OTC derivative contracts that lack a clear business rationale or
economic justification in order to evade the application of EMIR
 Art. 2 of EMIR (in force 10 October 2014)
• A contract will have a direct, substantial and foreseeable effect within the EU
where:
 at least one TCE benefits from a guarantee from an EU FC above a certain cumulative
threshold; or
 two TCEs enter an OTC derivative contract through their branches in the EU, provided
the TCEs would qualify as FCs if established in the EU
• TCEs are encouraged to notify their counterparties if they have an EU FC
guarantor
7
2. Who is in scope? – Extra-territoriality (cont.)
 Cumulative thresholds – a guarantee will qualify if:
•
it covers liability under one or more OTC derivative contracts for an aggregated notional
amount of at least €8 billion (or part of such liability, in which case this threshold should
be reduced proportionally); and
•
it is at least equal to 5 per cent. of the EU guarantor’s total ‘current exposures’ (as
defined in the Capital Requirements Directive) under OTC derivative contracts
 Liability that arises from OTC derivative contracts must reach the
€8 billion threshold for the guarantee to be at risk of qualifying
 Applicability of the thresholds is to be considered on an ongoing basis
 TCEs may be directly subject to clearing and risk mitigation obligations under
EMIR in the following circumstances:
•
the clearing obligation will apply directly to a TCE that would be subject to the clearing
obligation if it were established in the EU when it enters into OTC derivative contracts
with FCs/NFCs+
•
the requirement to use certain risk mitigation techniques extends to all counterparties
8
2. Who is in scope? – Equivalence
 Art. 13 of EMIR is designed to avoid duplicative or conflicting rules
 If at least one TCE is established in an ‘equivalent jurisdiction’, the parties can
adhere to the rules of that jurisdiction rather than EMIR
 TCEs in non-equivalent jurisdictions must ensure EMIR compliance
 The European Commission (EC) has mandated ESMA to provide technical advice
on regimes in: Australia, Canada, Hong Kong, Japan, India, Singapore, South
Korea, Switzerland and the United States
9
2. Who is in scope? – Cross-border
 EMIR ‘bites’ in cross-border transactions between a TCE and an EU counterparty
 Clearing obligation:
•
affects both the EU FC/NFC+ and the TCE that would be subject to the obligation if
established in the EU
•
the market view is that responsibility lies with an EU counterparty to ensure compliance
 Risk mitigation:
•
obligation applies even if the TCE would not be subject to EMIR
•
burden is on EU counterparty to ensure compliance by agreeing measures with its TCEs
10
3. EMIR – implementation timeline
Q4
1st Clearing Obligation
Category 1
Q1:
First CCP authorised
Q2
1st Clearing Obligation RTS published in OJ
2013
Q1:
Timely Confirmations
Daily valuations
NFC+ notification
Q3: Portfolio reconciliation
Portfolio compression
Dispute resolution
2014
2015
Q4
1st Clearing Obligation
Category 3
Q2
1st Clearing Obligation
Category 4
Q2
1st Clearing Obligation
Category 2
2016
2017
2018
Q1: / Q3: 12 February / 11
August Reporting to TRs
Q3: Phase‐in of variation margin and initial margin
Note: Presupposes (i) ESMA delivers revised draft RTS in Q1 2015, the EC adopts the revised draft RTS in Q2 2015 and the Council/Parliament do not
object and do not extend their three (3) month objection period and (ii) the margin RTS are endorsed by the EC in the form proposed during the
consultation phase.
11
4. What is already live?
 15 March 2013
• NFC notification (Art. 10 of EMIR):
 NFCs must immediately notify the competent authority (ie, in the UK, FCA) if their (and
their non-financial affiliates’) positions in OTC derivative contracts of the same asset
class (excluding hedging positions) exceed/no longer exceed specified clearing
thresholds in respect of such class
• Timely confirmations (Art. 11(1) of EMIR):
 OTC derivative contracts between in scope counterparties must be confirmed by T+1
for contracts between FCs/NFC+ and T+2 for contracts with a NFC FCs must have procedures for monthly reporting of unconfirmed transactions
• Daily valuation (Art. 11(2) of EMIR):
 FCs and NFC+ must carry out daily mark-to-market valuations or, where market
conditions prevent this, mark-to-model valuations
12
4. What is already live? (cont.)
 15 September 2013
• Portfolio reconciliation (Art. 11(1) of EMIR):
FCs and NFCs must agree processes for regular portfolio reconciliation with
counterparties, in frequencies as follows:
 FC/NFC+: each business day (if 500 + OTC derivative contracts outstanding); weekly (if 51 - 499
OTC derivative contracts outstanding per week); quarterly (if up to 50 OTC derivative contracts
outstanding per quarter)
 NFC-: quarterly (if 100+ OTC derivative contracts outstanding per quarter); annually (if up to 100
OTC derivative contracts outstanding)
• Portfolio compression (Art. 11(1) of EMIR):
 FCs and NFCs must have processes in place to take advantage of opportunities where
transactions can be terminated and replaced with an OTC derivative contract of a lower combined
notional value
• Dispute resolution (Art. 11(1) of EMIR):
 FCs and NFCs must agree procedures for identifying, recording, monitoring and resolving of
disputes; FCs must report unresolved disputes to the competent authority (ie. FCA)
13
4. What is already live? (cont.)
 12 February 2014 / 11 August 2014
• Reporting to TRs (Art. 9 of EMIR):
 When: Counterparties must report all of their contracts (OTC and ETD) to a registered
or recognised TR or to ESMA by T+1
 Delegation: Counterparties may delegate the reporting to a third party but retain
responsibility for the reporting obligation
 TRs: Six TRs authorised so far: DDRC, REGIS-TR, CME TR, KDPW, ICE TVEL,
UnaVista
 What needs to be reported: (1) Common Data, including main characteristics of the
trade such as the type of derivative, underlying, maturity, notional value, price and
settlement data, economic terms and trade identifiers; (2) Counterparty Data, including
counterparty classification, beneficiary information and legal entity identifiers of the
parties; (3) Collateral and Valuation Data, FCs and NFC+ have to report the daily
mark-to-market (or mark-to-model) value as well as the value of collateral posted
14
4. What is already live? (cont.)
 When did the reporting obligation start:
12 February 2014 for Common Data and Counterparty Data
11 August 2014 for Collateral and Valuation Data
Contracts (OTC and ETD) outstanding on 16 August 2012 and still outstanding on 12
February 2014 (the reporting start date) had to be reported within ninety (90) days of
the reporting start date
Contracts (OTC and ETD) entered into (i) before 16 August 2012 (and still outstanding
on 16 August 2012); and (ii) on or after 16 August 2012, but in each case not
outstanding on or after the reporting start date, must be reported within three (3) years
of the reporting start date
 LEI: Counterparties should obtain a global legal entity identifier (LEI) when available
for the purpose of reporting Counterparty Data (by registering with a pre-LOU (Local
Operating Unit), ie. GMEI Utility)
15
4. What is already live? (cont.)
Checklist
FC
Confirm uncleared OTC derivative contracts by T+1
Prepare a report on unconfirmed uncleared OTC derivative contracts for more than five (5) business days
Calculate mark‐to‐market/mark‐to‐model valuation of uncleared OTC derivative contracts daily
Obtain a Legal Entity Identifier (LEI) Agree processes with counterparties for portfolio reconciliation with respect to uncleared OTC derivative contracts:
Each business day (if 500+ outstanding uncleared OTC derivative contracts)
Weekly (if 51‐499 outstanding uncleared OTC derivative contracts per week)
Quarterly (if up to 50 outstanding uncleared OTC derivative contracts per quarter)
Following conclusion of an uncleared OTC derivative contract
Monthly (to be provided to the competent authority upon request only)
Ongoing
Before reporting derivative contracts (OTC and ETD)
Before trading
Ensure processes are in place to take advantage of portfolio compression opportunities (vis‐à‐vis Ongoing
counterparties where 500+ uncleared OTC derivative contracts are outstanding). At least twice a year analyse the possibility to conduct a portfolio compression and, if appropriate, carry out the same
Agree processes with counterparties to uncleared OTC derivative contracts to identify, record, monitor and Before trading
resolve disputes on reported portfolio data
Report unresolved disputes with respect to uncleared OTC derivative contracts for an amount higher than EUR Following disputes
15million and outstanding for at least 15 business days to the competent authority (ie. FCA)
Report trade data to a TR (or ESMA if no TR available) by T+1
Following conclusion, termination or modification of a
derivative contract (OTC and ETD)
16
4. What is already live? (cont.)
Checklist (cont.)
NFC+
Assess whether positions in OTC derivatives contracts (excluding contracts for hedging purposes) exceed/cease Ongoing
to exceed clearing threshold and notify competent authority (ie, FCA) immediately of change
Confirm uncleared OTC derivatives contracts by T+1
Calculate mark‐to‐market/mark‐to‐model valuation of uncleared OTC derivative contracts daily
Obtain a Legal Entity Identifier (LEI) Following conclusion of an uncleared OTC derivative contract
Ongoing
Before reporting derivative contracts (OTC and ETD)
Agree processes with counterparties for portfolio reconciliation with respect to uncleared OTC derivative Before trading
contracts:
Each business day (if 500+ outstanding contracts)
Weekly (if 51‐499 outstanding contracts per week)
Quarterly (if up to 50 outstanding contracts per quarter)
Ensure processes are in place to take advantage of portfolio compression opportunities (vis‐à‐vis counterparties Ongoing
where 500+ uncleared OTC derivative contracts are outstanding). At least twice a year analyse the possibility to conduct a portfolio compression and, if appropriate, carry out the same
Agree processes with counterparties to uncleared OTC derivative contracts to identify, record, monitor and resolve disputes on reported portfolio data
Report trade data to a TR (or ESMA if no TR available) by T+1
Delegate authority to report trade data to a third party (optional)
Before trading
Following conclusion, termination or modification of a
derivative contract (OTC and ETD)
Ongoing
17
4. What is already live? (cont.)
Checklist (cont.)
NFC‐
Assess whether positions in OTC derivatives contracts (excluding contracts for hedging purposes) exceed/cease to exceed clearing threshold and notify competent authority (ie. FCA) immediately of change
Ongoing
Confirm uncleared OTC derivatives contracts by T+2
Following conclusion of an uncleared OTC derivative contract
Before reporting derivative contracts (OTC and ETD)
Obtain a Legal Entity Identifier (LEI) Agree processes with counterparties for portfolio reconciliation with respect to uncleared OTC derivative Before trading
contracts:
Quarterly (if 100+ outstanding contracts per quarter)
Annually (if up to 100 outstanding contracts per quarter)
Ensure processes are in place to take advantage of portfolio compression opportunities (vis‐à‐vis counterparties Ongoing
where 500+ uncleared OTC derivative contracts are outstanding). At least twice a year analyse the possibility to conduct a portfolio compression and, if appropriate, carry out the same
Agree processes with counterparties to uncleared OTC derivative contracts to identify, record, monitor and resolve disputes on reported portfolio data
Before trading
Report trade data to a TR (or ESMA if no TR available) by T+1
Following conclusion, termination or modification of a derivative contract (OTC and ETD)
Ongoing
Delegate authority to report trade data to a third party (optional)
18
5. What is coming into force? – Margining
 Margining of uncleared OTC derivative contracts
• Art. 11(3) of EMIR
• On 14 April 2014, the European Supervisory Authorities (ESAs) (ie. EBA,
ESMA and EIOPA) published a consultation paper on the exchange of margin
for uncleared OTC derivative contracts, proposing a start date of 1 December
2015 (subject to the phase-in requirements for initial margin)
• Initially, ESAs expected to deliver the final draft RTS to the EC by end of 2014
• To date, the final rules have not yet been published by European, US and
Japanese authorities
19
5. What is coming into force? – Margining (cont.)
 Determining applicable margin rules
•
Counterparties will need to consider and determine:
 Which (if any) margin regulations apply (based on the relevant cross-border rules)
 Scope of application of relevant margin rules: (A) not applicable or (B) VM only or (C) VM and IM
•
Key information to make such determination:
 Parties’ status under each of the margin regulations
 Parties’ average aggregate notional amount (AANA) under each of the margin regulations
 Relationship-specific information (eg, domicile of a guarantor)
•
To assist in obtaining the necessary information, ISDA is developing a self-disclosure
form (to be available on ISDA Amend) – in particular, this form will contain information as
to (1) a party’s status under various margin regulations, (2) affiliates and (3) whether the
AANA thresholds have been crossed under various margin regulations (tracking will need
to be done on a group basis)
20
5. What is coming into force? – Margining (cont.)
 Draft RTS – key concerns
• Non-EU NFC-s and sovereigns: non-EU entities that would not qualify as FCs
or NFC+s and non-EU sovereigns should not be required to post margin
• Initial margin models: a number of model requirements are overly rigid and
prescriptive
• Concentration limits: too restrictive
• Timing and VM phase-in: at least two (2) years (from the adoption of final
rules) needed for the implementation of the margin requirements and the ESAs
should phase in the requirement to post VM
• Documentation: documentation requirements (particularly the requirement to
enter into agreements with NFC-s) are overly burdensome
• International consistency / cross-boarder issues: margin rules should be
consistent across the major financial jurisdictions
21
5. What is coming into force? – Margining (cont.)
 Draft RTS – overview
• Applicable prospectively
• Five chapters:
 Counterparties’ risk management procedures
 Margin methods
 Eligibility and treatment of collateral
 Operational procedures
 Procedures concerning intra-group OTC derivative contracts
22
5. What is coming into force? – Margining (cont.)
 Counterparties’ risk management procedures – general
• Collection of Initial Margin (IM)
 collected “to cover potential future exposure to the other counterparty providing the
margin in the interval between the last margin collection and the liquidation of positions
following a default of the other counterparty”
→ on gross basis (ie. IM amounts cannot be netted against each other)
• Collection of Variation Margin (VM)
 collected “to reflect current exposures resulting from actual changes in market price”
→ on net basis
• Parties should agree eligible collateral upfront
23
5. What is coming into force? – Margining (cont.)
 IM
• Extension: 1 December 2015 ››› 1 September 2016
• Phase-in: from 1 September 2016 to 1 September 2020
• Must be collected within one (1) business day of the execution of a new OTC
derivative contract
• The total amount of IM collected from another counterparty must be
recalculated and collected when:
 a new contract is executed with that counterparty;
 an existing contract with that counterparty expires;
 an existing contract triggers a payment (or delivery) other than posting or collecting
VM; or
 no IM recalculation has been performed in the last ten (10) business days
24
5. What is coming into force? – Margining (cont.)
IM phase-in thresholds
From 1 September 2016 Threshold Amount
2016
€3 trillion
2017
€2.25 trillion
2018
€1.5 trillion
2019
€0.75 trillion
2020
€8 billion
Note: The Threshold Amount is to apply at a consolidated group level with respect to average aggregate notional amounts of uncleared OTC derivative
contracts for March, April, May of the relevant year.
25
5. What is coming into force? – Margining (cont.)
 VM
• Extension: 1 December 2015 ››› 1 September 2016
• Phase-in: 1 September 2016 (covered entities above €3 trillion); 1 March 2017
(all other covered entities)
• Must be collected at least on a daily basis starting from one (1) business day
after the execution of the OTC derivative contract
• Based on the mark-to-market valuation of transactions under outstanding OTC
derivative contracts (Art. 11(2) of EMIR and Arts. 16 and 17 of RTS)
26
5. What is coming into force? – Margining (cont.)
 Counterparties’ risk management procedures – specific
• Counterparties may agree not to collect IM with respect to:
 physically settled foreign exchange forwards and swaps
 exchange of principal of a currency swap
• FCs may agree with their FC or NFC counterparties that IM will not be
exchanged if the total amount of margin exchanged is less than €50 million,
provided capital will be held against the party’s exposure to its counterparty.
Threshold covers all IM to be exchanged between counterparties at group level
• Counterparties may reduce the amount of IM exchanged by the value of the
margin threshold
• Full amount of VM to be exchanged with no applicable threshold
27
5. What is coming into force? – Margining (cont.)
 Counterparties’ risk management procedures – specific (cont.)
• Counterparties may agree a minimum transfer amount of €500,000 covering
all IM and VM and excess collateral (if any)
• FCs/NFC+s may agree not to collect IM or VM from NFC-s and/or
counterparties exempt from EMIR
• Counterparties may agree that IM and VM are not posted by covered bond
issuers and cover pools if certain conditions are met, including:
 derivative must not terminate in case of default of the covered bond issuer;
 legal overcollateralisation of at least 102%; and
 derivative used only for hedging purposes
28
5. What is coming into force? – Margining (cont.)
 Margin methods
•
Standardised method
 Annex IV of the draft RTS
 Notional amounts or underlying
values of the OTC derivative
contracts are multiplied by the
relevant haircuts – dependent,
essentially, upon residual maturity
• Initial margin models
 May be developed by a
counterparty or jointly by the two
counterparties or by a third party
agent
 No industry-wide common
approach to modelling
 Counterparties must notify the
relevant competent authority (ie,
FCA) if they are intending to use an
initial margin model
 ISDA is leading industry efforts to
develop a standard model for
calculating IM
29
5. What is coming into force? – Margining (cont.)
 Initial margin models – requirements
•
Calibration of the model
 based on historical data from a period of at least three (3) years
 at least 25% of stressed data
 recalibration at least every six (6) months
•
Primary risk factor and underlying classes
 IM to be calculated first at underlying class level
 total IM = sum of IM calculated for each underlying class
•
Assessments of the validity of the model’s risk assessments
 initial validation by independent parties
 at least annually
 a process for verifying at least annually that the netting agreements considered for IM calculation
are legally enforceable
 clear documentation showing all changes to the initial margin model and the tests performed
30
5. What is coming into force? – Margining (cont.)
 Eligibility and treatment of collateral
• Covers asset classes listed in the draft RTS – cash; gold; debt securities issued
by central governments, central banks, public sector entities, credit institutions,
investment firms; corporate bonds; equities; shares or units in UCITS
• Requirement for credit quality assessment in relation to certain asset classes
using one of the methodologies specified in the draft RTS:
 internal models (‘internal-ratings-based approach’ (if authorised))
 external credit assessments
• Specific eligibility criteria apply to certain asset classes
31
5. What is coming into force? – Margining (cont.)
 Eligibility and treatment of collateral (cont.)
• Limits on the concentration of collateral type for IM and VM will apply
 no limits applicable to cash
 concentration limits of 10%, 40% and 50%
• Haircuts applicable to market value of collateral
 standard methodology in Annex II of RTS (0.5% – 24%, depending in particular upon
the residual maturity and the type of securities)
 own estimates subject to criteria in Annex III of RTS
32
5. What is coming into force? – Margining (cont.)
 Operational procedures
• Exchange of collateral:
 a detailed documentation of policy (covering collateral levels, types and eligibility,
applicable haircuts) – updated at least annually
 processes for escalation of disputes with counterparties
 counterparties must agree in writing the terms of the operational process for the
exchange of collateral (including any segregation arrangements, settlement of margin
calls, methods for calculating and valuing collateral etc.)
 procedures to periodically verify the liquidity of the eligible collateral
• Segregation of IM
• No ability to re-hypothecate, re-pledge or otherwise re-use IM
33
5. What is coming into force? – Margining (cont.)
 Procedures concerning intra-group OTC derivative contracts
• Intra-group exemption (Art. 11(6) – (10) of EMIR) – regular monitoring of
intra-group exposures and the timely settlement of the obligations arising out of
intra-group OTC derivative contracts
• Avoid current or foreseen practical or legal impediments to the prompt transfer
of own funds or repayment of liabilities between the counterparties by:
 maintaining sufficient assets to satisfy transfers or repayments when due (no
operational obstacles etc.); and
 ensuring no restrictions under the applicable laws or any relevant contractual
relationships (the absence of currency or exchange controls, regulatory restrictions,
limitation on the ability to transfer funds etc.)
34
5. What is coming into force? – Margining (cont.)
 Documentation
• ISDA Working Group on Margining Requirements (WGMR)
• A new suite of collateral documentation required that will need to address
different (and potentially inconsistent) margin regulations
 New ISDA templates for Credit Support Documents being developed
 Contractual Architecture: (1) existing CSA, (2) new CSA for regulatory VM and nonregulatory IM (if posted), (3) (after the transition to regulatory IM) new Credit Support
Documents for regulatory IM
 Parties using English law documentation would use a title-transfer CSA for VM and a
separate CSD for segregated (regulatory) IM
• Custodial agreements (tri-party agreements) will be required in light of the
requirement for segregation of IM
• New or updated netting opinions may be necessary for counterparties in certain
jurisdictions
35
5. What is coming into force? – Margining (cont.)
Checklist
Establish/obtain the total gross notional values of uncleared OTC derivative contracts at a group level, in order to determine if the IM/VM is likely to apply in light of the phase‐in thresholds
Before margining obligation comes into force Identify a possibility to agree an opt‐out, in particular consider:
whether margin should be exchanged where the total collateral amount is equal to or lower than €500,000 whether the total amount of IM to be exchanged would be likely to be equal to or less than €50mm at a group level the position with respect to uncleared physically settled FX swaps/forwards or the exchange of principal on uncleared currency swaps (in each case, if any)
Review existing collateral arrangements with respect to uncleared OTC derivative contracts and, if required, repaper as appropriate
Review infrastructure and operational capabilities to ensure compliance with any operational requirements set out in EMIR (and related RTS) with respect to margining. Note that:
VM: first collected by T+1, then on a daily basis; calculated based on a daily valuation of the relevant
uncleared OTC derivative contract
IM: first collected by T+1, then recalculated each 10th business day or following certain events
Before margining obligation comes into force Establish/regularly revisit internal risk management procedures that are sufficiently robust to ensure timely exchange of margin and otherwise meet requirements set out in EMIR (and related RTS) with respect to margining
Establish/regularly revisit appropriate segregation arrangements with respect to IM to ensure compliance with specific requirements set out in EMIR (and related RTS). If margin is to be held by the collecting counterparty, discuss the ways how it will be segregated from the assets of other posting counterparties
Before margining obligation comes into force
Ongoing
Ongoing (and at least annually)
Ongoing
Obtain legal opinions in all relevant jurisdictions on whether the segregation arrangements meet the requirements At the inception of an uncleared OTC set out in EMIR (and related RTS)
derivative contract and then annually
Discuss and agree in writing whether IM will be calculated according to the Standardised Method or using the Initial Ongoing
Margin Model
36
5. What is coming into force? – Clearing
 What is clearing?
• Original OTC derivative contract between two counterparties is replaced by two
new contracts with a CCP
• Only clearing members (CM), who comply with strict membership criteria, can
clear through a CCP
• Generally, counterparties will become a client of a CM who will act as a clearing
broker
37
5. What is coming into force? – Clearing (cont.)
 Who is in scope?
• Counterparties required to clear all OTC derivative contracts between
FCs/NFC+s (and TCEs) (Art. 4 of EMIR)
• NFC+ = NFCs whose average notional positions in OTC derivative contracts
over 30 working days exceed certain ‘clearing thresholds’ in any derivatives
asset class (other than derivatives for hedging purposes as defined below) are
referred to as NFC+ and required to clear in all classes
Clearing Thresholds
Type of OTC derivatives
transaction
Gross Notional Value
Credit derivatives
€1 billion
Equity derivatives
€1 billion
Interest rate derivatives
€3 billion
Foreign exchange derivatives
€3 billion
Commodity derivatives and other
asset classes
€3 billion
38
5. What is coming into force? – Clearing (cont.)
 What is in scope?
• OTC derivative contracts pertaining to an asset class which is subject to the
clearing obligation which will be entered into or novated either:
 on or after the date of the clearing obligation takes effect; or
 between the date of notification to ESMA, but before the date the clearing obligation
takes effect if the OTC derivative contracts have a remaining maturity higher than the
minimum remaining maturity (MRM) determined by the EC (Frontloading)
• OTC derivative contracts for hedging purposes are not in scope for the clearing
threshold when determining the NFC category:
 “objectively measurable as reducing risks directly relating to the commercial activities
or treasury financing activities” of an NFC or its group
 only needs to constitute a hedge at time of entry into transaction
39
5. What is coming into force? – Clearing (cont.)
 Exemptions
• Intra-group (including a TCE) OTC derivative contracts. The EC proposed that
third countries be deemed equivalent until the earlier of (i) three (3) years from
the date of the first clearing RTS; or (ii) a decision is adopted on the
equivalency of the third country concerned. However, ESMA has challenged
the legal basis for this decision
• OTC derivative contracts associated with covered bond programmes
• Pension schemes until August 2017
40
5. What is coming into force? – Clearing (cont.)
 Key concepts
•
Margin
 IM is retained by CCP; VM is paid by the CCP to the CM ‘in the money’
 CM may need to convert or exchange ineligible collateral
•
Segregation
Client can choose level of segregation:
 Individual client account
 Omnibus client account
•
Portability
If the CM defaults, the CCP is obliged to:
 transfer the positions and assets relating to the client to a new CM (‘porting’)
 if porting is not possible, attempt to return the assets directly to the client
•
Relationships with at least two CMs is recommended
41
5. What is coming into force? – Clearing (cont.)
 Current position
• ESMA has published three consultation papers:
 OTC interest rate derivative classes and OTC equity, interest rate futures and options
derivative classes
 OTC credit derivative classes
 OTC foreign exchange non-deliverable forward derivative class
• Other asset classes (such as OTC commodity derivatives) to be covered in
subsequent consultation papers
• On 1 October 2014, ESMA submitted to the EC a draft RTS in relation to in
scope OTC interest rate derivative classes. On 6 January 2015, the EC
endorsed the draft RTS with amendments and returned it to ESMA. On 29
January 2015, ESMA delivered to the EC an opinion with revised RTS and on 9
March 2015, ESMA delivered a revised opinion but did not make any material
changes
42
5. What is coming into force? – Clearing (cont.)
 Consultation no.1 – OTC interest rate derivative classes
• in scope:
 Types: float-to-float swaps (basis swaps), fixed-to-float interest rate swaps (plain
vanilla IRS), forward rate agreements and overnight index swaps
 Characteristics: floating reference rate, settlement currency, currency type, maturity,
existence of embedded optionality and notional amount type
 CCPs: Nasdaq OMX (Sweden), Eurex Clearing AG (Germany), LCH.Clearnet Limited
(UK) and CME Clearing Europe Limited (UK)
• out of scope:
 CCP: KDPW_CCP is only authorised for OTC interest rate swaps denominated in
Polish Zloty
43
5. What is coming into force? – Clearing (cont.)
 Consultation no.1 – OTC equity, interest rate futures and options
derivative classes
• out of scope
 OTC Interest rate future and option derivative classes cleared by Nasdaq OMX
(Sweden) and LCH.Clearnet Limited (UK)
 OTC equity derivative classes cleared by Nasdaq OMX (Sweden) and LCH.Clearnet
Limited (UK)
44
5. What is coming into force? – Clearing (cont.)
 Consultation no.2 – OTC credit derivative classes
• in scope
 Type: European untranched index credit default swaps
 CCPs: LCH.Clearnet SA (France) (with ICE Clear Europe expected to be authorised
by the time the RTS enters into force)
• out of scope
 Type: single name credit default swaps
 CCPs: Nasdaq OMX (Sweden) and LCH.Clearnet SA (France)
 Phase-in periods, categories of counterparties and MRM are likely to mirror the
position taken in respect of OTC interest rate derivative classes
 Draft RTS to be submitted shortly (ESMA delayed submission in order to allow the
EC to assess the draft RTS in respect of OTC interest rate derivative classes)
45
5. What is coming into force? – Clearing (cont.)
 Consultation no.3 – OTC foreign exchange non-deliverable forward
derivative class (NDFs)
• in scope
 Type: cash settled foreign exchange forward contracts
 Characteristics: currency pair, settlement currency, settlement type, maturity
 CCPs: LCH.Clearnet Limited (UK)
 Following feedback on the consultation paper, ESMA is not proposing a clearing
obligation in respect of NDFs
46
5. What is coming into force? – Clearing (cont.)
 Proposed timetable and categories of counterparties
• Category 1 – 6 month phase-in period after entry into the RTS
 Entities which are, at the date the RTS comes into force:
• clearing members of at least one CCP authorised to clear at least one of the
classes subject to the clearing obligation; and
• their clearing membership allows it to clear at least one of the classes subject to the
clearing obligation
• Category 2 – 12 month phase-in period after entry into the RTS
 FCs and AIFs (that are NFC+) not included in Category 1 which belong to a group
whose aggregate month-end average notional amount outstanding of uncleared OTC
derivative contracts for (three months after the publication of the RTS in the Official
Journal) is above €8 billion
47
5. What is coming into force? – Clearing (cont.)
• Category 3 – 18 month phase-in period after entry into the RTS
 FCs and AIFs (that are NFC+) not included in Category 1 or 2
• Category 4 – 3 year phase-in period after entry into the RTS
 NFC+ not included in Category 1, 2 or 3
• If an OTC derivative contract is entered into between counterparties in different
categories, the date the clearing obligation will take effect is the later of the two
• Example: a FC in Category 1 will not be required to clear an OTC derivative
contract with a NFC+ in Category 4 until three (3) years after the RTS enters
into force
48
5. What is coming into force? – Clearing (cont.)
 Clearing – implementation timeline
Q3
RTS due to come into force (20 days after publication in the Official Journal)
Q3
End of 12 month phase‐in period for Category 2 counterparties
Q1
End of 6 month phase‐in period for Category 1 counterparties
2015
2016
Q1
End of 18 month phase‐
in period for Category 3 counterparties
2017
Q3
End of 3 year phase‐in period for Category 4 counterparties
2018
Note: Presupposes (i) ESMA delivers revised draft RTS in Q1 2015, the EC adopts the revised draft RTS in Q2 2015 and the Council/Parliament do
not object and do not extend their three (3) month objection period.
49
5. What is coming into force? – Clearing (cont.)
 Frontloading
• The obligation to clear OTC derivative contracts which are subject to the
clearing obligation entered into or novated between the date of notification to
ESMA and the date the clearing obligation takes effect if the OTC derivative
contracts have a remaining maturity higher than the MRM (as at the date the
clearing obligation applies) as determined by the EC
• Does not apply to NFC+s
• Does not apply to Category 3 counterparties
• If an OTC derivative contract is entered into between counterparties in different
categories, the MRM is the longer of the two
50
5. What is coming into force? – Clearing (cont.)
 Frontloading timeframes
• Category 1
 Period A – between the notification to ESMA and two (2) months after the entry into
the RTS
• no contracts in Period A will be subject to the frontloading obligation
 Period B – between two (2) months after the entry into the RTS and the date on
which the clearing obligation takes effect
• MRM is set at six (6) months
• Category 2
 Period A – between the notification to ESMA and five (5) months after the entry into
the RTS
• no contracts in Period A will be subject to the frontloading obligation
 Period B – between five (5) months after the entry into the RTS and the date on
which the clearing obligation takes effect
 MRM is set at six (6) months
51
5. What is coming into force? – Clearing (cont.)
 Clearing Documentation
• Between CCP and CM
 CCP Rules
• Between CM and Client
 Master Agreement (ISDA Master or FOA Terms of Business)
 Client Clearing Agreement (based on industry initiatives)
• ISDA Master: ISDA/FOA Addendum (cleared and uncleared OTC derivatives, not
ETDs)
• FOA Terms of Business: ISDA/FOA Addendum or FOA Clearing Module (cleared
OTC and ETD, not uncleared OTC derivatives)
 Confirmations
 Collateral Agreement (Credit Support Annex)
52
5. What is coming into force? – Clearing (cont.)
 Considerations with respect to Clearing Documentation
• Collateral
 Existing CSA disapplied and separate CSA is created for each CCP service
• Ability to port transactions
 Client right to transfer to replacement CM but subject to conditions
 CCP obligation on default of CM
• Events of Default
 Default of Client, CM or CCP
• Liability/Indemnity
 CM is a ‘riskless’ principal
53
5. What is coming into force? – Clearing (cont.)
Checklist
Seek to identify (based on consultation papers etc.) which traded products will be subject to mandatory clearing
Identify which category relevant counterparties will fall into for clearing purposes and determine if frontloading will apply
Before clearing obligation comes into force
RTS enters into force
Identify which counterparties will be required to comply with clearing
Ongoing
Identify whether any exemptions apply:
Intra‐group Covered bonds
Consider the clearing arrangements in place:
Clearing Member relationships CCP relationships Specify level of segregation (in writing)
Documentation Margin requirements
Discuss and consider which type of Client Clearing Agreement is most appropriate:
ISDA/FOA Client Cleared OTC Derivatives Addendum
FOA Clearing Module
Clearing Members own clearing documentation
CCP based initiatives
Now
Ongoing
Ongoing
54
6. Expected developments
Q2 2015
•
•
•
•
•
Expected delivery of the Draft RTS to the EC in respect of OTC credit derivative classes
Expected delivery of the Draft RTS to the EC in respect of margining of uncleared derivatives
Possible publication of the margin RTS in the Official Journal Other third country central banks expected to be added to the list of exempted entities in Art.1(4) EMIR
NCAs expected to start accepting applications for the intra‐group exemption to the clearing obligation
Q3 2015
• Publication by the EC of a general report regarding EMIR implementation pursuant to Art. 85(1) EMIR by 17 August 2015
• Start of two (2) year extension to exemption from clearing obligation for pension schemes
• Possible publication of the 1st clearing obligation RTS in the Official Journal
55
6. Expected developments
2016
• Possible start date for clearing obligation for Category 1 and 2 counterparties
• ESMA to list pension arrangements specifically exempted from the clearing obligation by the national competent authorities (before 1st clearing obligation applies for Category 2 counterparties)
• Start date for implementation of margin requirements for uncleared OTC derivatives (subject to phase‐in requirements)
2017
• Possible start date for clearing obligation for Category 3 counterparties
• Deadline for reporting to TRs pre‐existing contracts that were not outstanding on the reporting start date
2018
• Possible start date for clearing obligation for Category 4 counterparties
56
Conclusion and Questions
57
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58
EMIR: "an overview"
The European Market Infrastructure Regulation (Regulation no. 648/2012) (‘EMIR’) was first proposed by the
European Commission (‘EC’) on 15 September 2010, and finally agreed by the European legislature on 4 July
2012. It was published in the Official Journal on 27 July, and on 16 August it legally entered into force.
As a Regulation, EMIR will be directly effective in all member states without the need for any national legislation.
However, under the four-stage process by which EU financial legislation is made, EMIR is only a ‘framework’, and
lacks much technical detail.
Instead, it requires the European Securities & Markets Authority (‘ESMA’) to develop “regulatory technical
standards” (‘RTS’) on various points, and then provide them to the EC, who will implement them as directly
effective secondary legislation.
The deadline for ESMA to develop these is 30 September 2012. A set of draft RTS were published by ESMA on
25 June and final RTS on 27 September. The deadline set by the G20 for implementing EMIR is the end of 2012.
This report comprises a short summary of the clearing obligation that is the central part of EMIR; some of the
main debates over the Regulation, including amendments adopted and rejected; and a detailed breakdown of the
contents of the published legislation.
The Clearing Obligation
EMIR implements new requirements for the clearing of OTC derivatives that were agreed by the G20 in 2009 in
Pittsburgh:
All standardised OTC derivatives contracts should be […] cleared through central counterparties by end-2012 at
latest. OTC derivatives contracts should be reported to trade repositories. Non-centrally cleared contracts should
be subject to higher capital requirements.
EMIR requires that some (but not all) OTC derivatives contracts must be cleared through central counterparties
(‘CCPs’). Contracts that are not cleared through a CCP will be made subject to increased collateral requirements
and other safeguards.
EMIR also includes various prudential and administrative requirements for CCPs, as well as a new reporting
requirement for OTC derivatives contracts.
What will the clearing obligation apply to?
The classes of OTC derivative contract to which the clearing obligation shall apply will be decided either:
-
by ESMA, after considering the classes of contract that national regulators have authorised CCPs to
clear, and deciding in some of these cases to make clearing mandatory for such contracts; or
-
by ESMA acting on its own initiative (subject to consultation).
These are known as the ‘bottom-up’ and ‘top-down’ approaches, respectively.
Who will the clearing obligation apply to?
EMIR will apply to
-
financial counterparties; and
-
non-financial counterparties – i.e. everyone else – who hold large positions in OTC derivatives (other
than those OTC derivatives entered into for hedging purposes).
There are certain exemptions for public bodies, pension funds, and intra-group transactions.
Developments
Scope
As cited above, the impetus for EMIR was the 2009 agreement of the G20 on OTC derivatives. The working party
of the Council of the European Union had at one point suggested that the clearing obligation be extended to
cover all derivatives, but unsurprisingly this did not make it into the final Regulation.
UCITS
The European Parliament’s Economic and Monetary Affairs Committee (‘ECON’) had suggested a “narrowlydefined” derogation for UCITS that carry out only low-volume derivatives transactions, exempting them from the
EMIR requirements. This was not accepted, however.
Credit Default Swaps
The Report of the European Economic and Social Committee (‘EESC’) on EMIR described Credit Default Swaps
(‘CDSs’) as “a potential mortal danger to the world financial system” – and warned the EC not to overestimate the
benefits that CCPs could bring to CDS markets. Nevertheless, neither the final version of EMIR, or the draft
ESMA technical standards of 25 June makes any specific provision for CDSs.
SMEs/SMUs De Minimis Exemptions
ECON had also suggested “sector-specific clearing thresholds” for small-to-medum-sized undertakings (‘SMUs’),
with a view to exempting some of these from the clearing obligation, as well as a de minimis rule with regard to
the reporting obligation. Neither appear in the final version of EMIR: there is a single clearing threshold for nonfinancial counterparties, and all financial counterparties are automatically subject to the clearing obligation. There
appear to be no exemptions from the “comprehensive reporting requirement”, either in EMIR itself, or in the draft
regulatory technical standards on reporting prepared by ESMA. The reporting requirement will therefore apply to
all counterparties (undefined in EMIR, but defined by ESMA in the draft regulatory technical standards as both
financial and non-financial counterparties; i.e. all undertakings.)
Reporting Obligation for Non-Financial Counterparties
The original EC proposal for EMIR had required that non-financial counterparties should only report OTC
derivatives transactions above a certain level – an ‘information threshold’ for the reporting obligation analogous to
the ‘clearing threshold’ for the clearing obligation. ECON proposed that, subject to the de minimis rule above, the
reporting obligation for non-financial counterparties should apply to all derivatives trades, rather than just those
above the information threshold. The information threshold was subsequently abandoned in the final version of
EMIR.
Clearing Threshold for Non-Financial Counterparties
The original EC proposal had stated that non-financial counterparties would become subject to the clearing
obligation immediately after exceeding the clearing threshold. ECON proposed, instead, that the obligation should
only apply if the threshold had been exceeded on 90 consecutive days, and that subsequently firms should have
six months in which to meet their new clearing obligations. In the final text, a 30-day rolling average is used, and a
period of four months is allowed.
In Depth
Arts. 1-3: Scope and Definitions
‘Financial counterparties’ are defined as:
-
investment firms authorised under MiFID;
-
credit institutions authorised under CRD;
-
insurance undertakings authorised under the First Non-Life Directive;
-
assurance undertakings authorised under the Consolidated Life Directive;
-
reinsurance undertakings authorised under the Reinsurance Directive;
-
UCITS authorised under UCITS;
-
IORPS authorised under IORPS; and
-
Alternative Investment Funds authorised under AIFMD.
All other undertakings are ‘non-financial counterparties’.
Various public bodies are excluded from the clearing obligation (but not the reporting obligation), as are
certain arrangements concerning pensions (see ‘Implementation and Transitional Provisions etc.’ below).
Art. 4: Establishing the Clearing Obligation
The clearing obligation will apply to certain types of OTC derivatives contracts (as further described below)
entered into:
-
between two financial counterparties; or
-
between one financial and one non-financial counterparty, where the latter has exceeded the threshold
limit; or
-
between two non-financial counterparties, both of which have exceeded the threshold limit; or
-
between a financial counterparty (or non-financial counterparty over the threshold) and a third country
party that would have been subject to the obligation were it based in the EU; or
-
between two such third country parties, provided that the contract “has a direct, substantial and
foreseeable effect” within the EU. This is in part an anti-avoidance measure, and will be elaborated upon
by ESMA in subsequent legislation.
If the clearing obligation applies to a contract - because it concerns a type of OTC derivative covered by the
Regulation, and because both parties fall within one of the categories above – then the contract must be cleared
through a CCP.
In this case both counterparties must either:
-
become a clearing member of a CCP;
-
become the client of a clearing member; or
-
establish indirect clearing arrangements.
Intragroup transactions are mostly exempt from the clearing obligation (subject to certain notification, risk
management and third country provisions in Art. 3).
Arts. 5-6: The Procedure for Applying the Clearing Obligation to Classes of Derivatives
This establishes both the ‘top-down’ and ‘bottom-up’ procedures for recommending derivatives for central clearing
which are described above.
Article 5 also provides ESMA with a set of criteria to consider when deciding whether or not to apply the clearing
obligation to a given class of derivatives (“with the overarching aim of reducing systemic risk”), and requires them
to produce secondary legislation elaborating on these criteria.
The details as to which derivatives are subject to the clearing obligation will be kept in a register run by ESMA.
Arts. 7-8: Access to CCPs for Trading Venues, and to Trading Venues for CCPs
In order to avoid any “market distortion” caused by the new CCP clearing requirement (e.g. an unfair advantage
for CCPs already linked with trading venues), EMIR includes a requirement that CCPs must accept clearing
contracts from trading venues (and trading venues must provide trade feeds to CCPs) on a non-discriminatory
and transparent basis.
Art. 9: Establishing the Reporting Obligation
Both CCPs and the counterparties themselves must report the details of any derivatives contract (including
any modifications or terminations of that contract) to a trade repository as soon as possible, and no later than the
next working day. In the absence of a trade repository these must be reported to ESMA. Reporting may be
delegated. This reporting requirement applies to all derivatives contracts that were entered into, or remained
outstanding, on or after 16 August 2012, and supersedes any contractual restrictions on disclosure of information.
ESMA’s regulatory technical standards will set out the precise details to be reported.
Art. 10: Threshold Limit for Non-Financial Counterparties
This establishes that non-financial counterparties will be subject to any clearing obligation stated to apply in
respect of an OTC derivative contract if their 30-day rolling average position in such OTC derivative contracts
exceeds a certain threshold. Derivatives contracts entered into for the direct purpose of hedging such
counterparties’ commercial or treasury financing risks do not count towards the relevant threshold limit.
Once the clearing obligation applies to a non-financial counterparty it has four months in which to begin clearing
all future contracts.
If a non-financial counterparty can demonstrate to the national regulator that its 30-day rolling average position in
OTC derivatives no longer exceeds the clearing threshold, they will be thereafter excused from the clearing
obligation.
This article does not specify the precise threshold figure, but rather asks ESMA to establish this in regulatory
technical standards.
Art. 11: Additional Requirements and Safeguards for Non-CCP Cleared OTC Derivatives
Financial and non-financial counterparties entering into OTC derivative contracts that aren’t cleared through a
CCP must exercise due diligence to ensure that:
-
appropriate procedures and arrangements are put into place to measure, monitor and mitigate
operational and counterparty credit risk;
-
the terms of the relevant contract are confirmed in timely fashion, and by electronic means if possible;
-
processes for reconciling portfolios, managing risks, monitoring the value of contracts and identifying
disputes between parties are formalised;
-
contracts are marked-to-market on a daily basis (where market conditions allow);
-
they have risk management procedures that require timely, accurate and appropriately segregated
exchange of collateral; and
-
they hold an appropriate and proportionate amount of capital to manage the risk not covered by
exchange of collateral.
These requirements will also apply to OTC derivative contracts between third country entities that would have
been subject to the above requirement if they were based in the EU, provided that the contract “has a direct,
substantial and foreseeable effect” within the EU, or else is necessary to prevent evasion of the Regulation.
Requirements are lessened for intragroup transactions.
ESMA will provide further detail for this section in subsequent legislation.
Art. 12: Penalties
Member states are required to institute penalties for breaching of the rules. These must include “at least
administrative fines”, and all punishments should be made public, if possible. Infringement of the rules will not
affect the validity of any contract for OTC derivatives, or allow any party to a contract the right to claim
compensation from another.
Art. 13: Administrative Powers for Declaring Third Country Equivalence
Arts. 14-54: Rules for Central Counterparties
Most of EMIR is taken up with detailed rules for the authorisation and management of CCPs.
Arts. 55-82: Rules for Trade Repositories
ESMA has extensive powers to request information from trade repositories, and to levy fines (and other
punishments) on them for non-compliance.
Art. 83-91: Obligations on ESMA and National Regulators; Implementation and Transitional
Provisions etc.
The EC will review the effectiveness of EMIR by 17 August 2014.
For three years after EMIR enters into force (i.e. until 16 August 2015) pension schemes entering into OTC
derivatives contracts with the aim of reducing investment risks relating to the solvency of their arrangements will
be exempted from the clearing obligation. The exemption will also apply to entities which provide compensation to
members of pension schemes in case of default. (The additional requirements and safeguards for non-CCP
cleared OTC derivatives will still apply to these contracts, however.)
Contacts
Ash Saluja
Jason Harding
Partner
T: +44 (0)20 7367 2734
E: ash.saluja@cms-cmck.com
Partner
T: +44 (0)20 7367 3138
E: jason.harding@cms-cmck.com
Will Dibble
Michael Cavers
Partner
T: +44 (0)20 7367 3378
E: will.dibble@cms-cmck.com
Partner
T: +44 (0)20 7367 3413 E:
michael.cavers@cms-cmck.com
1 October 2012
204616472
This report is for general purposes and guidance only and does not constitute legal or professional advice and should not be relied on or treated
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EMIR: the Proposed European Regulation on
Derivatives, Central Counterparties and Trade
Repositories
On 15 September 2010 the European Commission published its Proposal for a Regulation of the European
Parliament and of the Council on derivatives, central counterparties and trade repositories in the EU (subject to
subsequent compromise drafts, the “Proposal”), otherwise known as the European Market Infrastructure
Regulation (“EMIR”).
The main purpose of the Proposal was to implement the mandatory clearing of certain standardised OTC (i.e.
over-thecounter) derivatives transactions, that meet predefined eligibility criteria, through central counterparties
(“CCPs”) and the reporting of those transactions to trade repositories, for use by relevant authorities. However,
subsequent drafts of the Regulation use a wider definition of ‘derivatives’, bringing transactions executed on
regulated markets into scope. This means the reporting requirements of the Regulation may apply to all types of
derivatives, not just OTC transactions, and ESMA could potentially require any type of derivatives contract to be
centrally cleared.
The Proposal is similar in scope to the OTC derivatives legislation that has recently been adopted in the United
States (i.e. the Dodd-Frank Act) and has been drafted in line with the initiative agreed by the G-20 in September
2009 that:
“All standardised OTC derivatives contracts should be traded on exchanges or electronic trading
platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest.
OTC derivative contracts should be reported to trade repositories. Non-centrally cleared contracts
should be subject to higher capital requirements.”
The Proposal sets out requirements for both financial counterparties and, in certain circumstances, nonfinancial counterparties, with respect to the clearing and reporting of derivatives contracts as well as setting out
requirements for CCPs and trade repositories. Certain entities, such as central banks, national bodies performing
similar functions and multilateral development banks, are specifically excluded from the scope of the Proposal.
The Proposal also sets out the obligations in relation to these matters of the new European Supervisory Authority,
the European Securities and Markets Authority (“ESMA”). ESMA will have responsibility for, amongst other
things, determining which types of derivatives transactions should be cleared, the supervision of trade repositories
and liaising with the relevant national competent authorities with respect to the authorisation of CCPs.
Clearing and Reporting Requirements
Financial counterparties and non-financial counterparties
All financial counterparties will be subject to the clearing requirements set out in the Proposal. The definition of
‘financial counterparty’ in the Proposal covers investment firms, insurance undertakings, assurance undertakings,
reinsurance undertakings, undertakings for collective investments in transferable securities (UCITS), institutions
for occupational retirement provision and alternative investment fund managers.
Non-financial counterparties, which are defined as undertakings established in the EU that do not fall within
any classification of financial counterparties, will only be subject to the clearing requirement if they exceed a
clearing threshold. The level of these thresholds is not set out in the Proposal. Instead, the Proposal delegates
powers to the EU Commission to specify these thresholds, which will be based on draft regulatory standards to be
drawn up by ESMA by 30 June 2012, after consultation with relevant authorities.
According to the Proposal, the threshold recommended by ESMA will take into account “systemic relevance
of…net positions and exposures” and will be reviewed periodically. Importantly, under the latest draft, hedging
transactions will not count toward the calculation of a non-financial counterparty’s positions for the purpose of the
threshold, but they will need to be cleared if the threshold is reached.
The rationale for these thresholds is that certain non-financial counterparties are active market participants and
enter into a large number of derivatives transactions and, therefore, excluding them entirely from the clearing and
reporting obligations could well undermine the effectiveness of these obligations.
Clearing Obligation
The Proposal sets out the following two approaches that will be used to determine which type of derivatives
transactions must be cleared:
1.
The “bottom-up” approach – Under this approach, a CCP will start clearing a certain type of derivatives
transaction after being authorised to do so by its national competent authority. Once this authorisation
has been given, such national competent authority is obliged to inform ESMA who will then decide
whether aclearing obligation should apply with respect to all such derivatives transactions across the EU.
Under the Proposal, ESMA has six months to make a decision and will base such a decision on certain
criteria such as the reduction of systemic risk in the financial system and the liquidity of contracts.
2.
The “top down” approach – In addition, ESMA may take the initiative and decide whether a particular
class of derivatives transactions should be subject to a mandatory clearing obligation. ESMA will notify
the EU Commission of any such derivatives transactions.
ESMA shall keep an up to date register of all eligible types of derivatives transactions that are required to be
cleared and the CCPs that are authorised to clear them.
Reporting Obligation
Whether or not they are subject to the clearing obligation, all counterparties, whether financial or non-financial,
and CCPs will be required to report the conclusion, modification and termination of every transaction of a certain
type to a trade repository by the working day following the execution, clearing or modification of each such
transaction. It is not yet clear whether this requirement will relate only to OTC derivatives transactions or all
derivatives, as defined in the Proposal.
CCPs
Authorisation
The competent authorities of Member States will continue to authorise (and withdraw the authorisation) for CCPs
to clear particular types of derivatives transactions. In order to facilitate, amongst other things, the CCP
authorisation process, the relevant competent authority will establish and chair a college consisting of other
relevant competent authorities, relevant central banks and ESMA. The college will have a number of
responsibilities such as providing a joint opinion about the CCP, the coordination of supervisory examination
programmes based on a risk assessment of the CCP and the determination of procedures and contingency plans
to address emergency situations. ESMA will, therefore, be able to play a central role in the authorisation of CCPs
by ensuring that the provisions in the Proposal for the authorisation of CCPs are consistency applied.
Organisational, Conduct of Business and Prudential Requirements
The Proposal sets out a number of organisational, conduct of business and prudential requirements for CCPs.
Although such requirements exist at a national level, they differ between different Member States and so the
Proposal seeks to harmonise such requirements across Member States.
The Proposal sets out various requirements for CCPs, such as having robust corporate governance
arrangements and that these are publicly disclosed, along with its prices and fees. In addition, the Proposal sets
out requirements relating to business continuity, segregation of assets and positions, default funds, default
procedures and transaction portability between clearing members.
The clearing process will entail a CCP becoming a counterparty to each derivatives transaction that it clears.
Given that the main aim of the Proposal is the reduction of counterparty risk, it is important that CCPs do not fail.
To that end, the various organisational, conduct of business and prudential requirements for CCPs have been
included in the Proposal in order to try and avoid any such failure.
Portability and Segregation
CCPs will only deal directly with clearing members, who will likely be major broker dealers. Other market
participants will, therefore, be required to clear derivatives transactions through chosen clearing members who
will, in turn, arrange for such derivatives transactions to be cleared through the relevant CCP.
The Proposal requires that CCPs segregate the assets and positions of each clearing member from both the
assets and positions of other clearing members and the assets and positions of the CCP. Following a pre-defined
trigger event, such as the insolvency of a clearing member, a CCP will, at the request of a client, transfer the
assets and positions of such clearing member to another clearing member. The alternative clearing member will
only be obliged to accept such assets and positions where it has previously agreed to do so pursuant to a
contractual relationship for that purpose.
Therefore, clients of a clearing member that is subject to such a pre-defined trigger event will be able to move or
“port” their assets and positions to another clearing member. It is anticipated that this will provide a certain degree
of market stability following the collapse of a major broker dealer and isolate market participants from
counterparty risk as much as possible.
Trade Repositories
Trade Repositories will be responsible for holding information on derivatives that is provided by counterparties
and CCPs pursuant to the reporting obligation described above. In contrast to the authorisation of CCPs, the
Proposal gives ESMA powers to register (and remove the registration) of trade repositories. Given the central role
played by trade repositories and their lack of fiscal responsibility the Commission is of the view that ESMA will be
in a better position to carry out these functions than a relevant national authority.
ESMA will also be responsible for ensuring that each trade repository is meeting the various requirements for
trade repositories set out in the Proposal. Trade repositories, like CCPs, will be required to ensure that they have
robust corporate governance arrangements in place. In addition, trade repositories will be required to, amongst
other things, ensure that the regulatory information that they hold on derivatives transactions is reliable and
secure.
Consideration and Implementation
The Proposal is still being considered by the Council of the EU, with political agreement expected by mid-May
2011. It is anticipated that the European Parliament will adopt the Proposal shortly afterwards, with ESMA to
provide the technical standards that are to apply by 30 June 2012 and for the Regulation to apply by the end of
2012.
It is important to note that the legislation will be a Regulation, not a Directive. This means that its provisions will
have direct effect and will not be subject to legislative interpretation at the national level. The Commission chose a
Regulation because it achieves a greater level of harmonisation than a Directive.
Contacts
Ash Saluja
Jason Harding
Partner
T: +44 (0)20 7367 2734
E: ash.saluja@cms-cmck.com
Partner
T: +44 (0)20 7367 3138
E: jason.harding@cms-cmck.com
Will Dibble
Michael Cavers
Partner
T: +44 (0)20 7367 3378
E: will.dibble@cms-cmck.com
Partner
T: +44 (0)20 7367 3413 E:
michael.cavers@cms-cmck.com
27 September 2012
This report is for general purposes and guidance only and does not constitute legal or professional advice and should not be relied on or treated
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© CMS Legal 2015. All rights reserved.
EMIR: the Final Adopted Regulatory Technical
Standards
Update
The European Market Infrastructure Regulation (Regulation no. 648/2012) (‘EMIR’) legally entered into force on
16 August 2012, but its implementation in practice depends on secondary legislation prepared by the European
Securities & Markets Authority (‘ESMA’).
ESMA published a discussion paper on 16 February 2012, followed by a set of draft implementing technical
standards (‘ITS’) and regulatory technical standards (‘RTS’) on 25 June. The final version of the RTS and ITS
were published on 27 September, and adopted1 by the European Commission (‘EC’) without modification on 19
December 2012. They are due to come into force around mid-March 2013. (Please see ‘The Future’, below, for
implementation details.)
What follows is a summary of those technical standards included in the adopted RTS and ITS which may be
relevant for parties entering into OTC derivative transactions. ESMA was also required to prepare RTS and ITS
on the specific requirements for CCPs and Trade Repositories (‘TRs’), which are not discussed in this note except
where relevant.
Regulatory Technical Standards provided by ESMA
1. RTS specifying which indirect clearing arrangements offer equivalent levels of protection to
either (i) being a clearing member oneself or (ii) being a client of a clearing member, and as
such would be acceptable methods of discharging the clearing obligation. (Art. 4(4) EMIR.)
ESMA’s original draft RTS of 25 June relating to indirect clearing arrangements received a “very large volume” of
responses, highlighting that the proposals for indirect clearing were unworkable both practically and legally. The
original draft was therefore substantially revised. The final RTS defines an “indirect clearing arrangement” as a set
of contractual arrangements which allows the client of a clearing member to provide clearing services to “a client
of a client of a clearing member”, i.e. its own clients. Rather than adopt a prescriptive approach, ESMA has set
out a broad framework intended to ensure that indirect clients can obtain an equivalent level of protection as
direct clients in a default scenario. It remains unclear how as a practical matter indirect clearing will work, in the
absence of further legislative change (particularly in relation to national insolvency regimes). ESMA will monitor
the development of indirect clearing arrangements.
The rules for parties to an indirect clearing arrangement are set out in Articles 1-4 of the final RTS and are broadly
as follows:
-
CCPs must:

not adopt business practices that would act as a barrier to clients establishing indirect clearing

arrangements on reasonable commercial terms;

identify, monitor and manage certain risks that might arise from indirect clearing arrangements;
1
With one exception, concerning colleges of central counterparties. This aspect of EMIR is not dealt with in this document,
however. The EC has stated that the rejection of this one RTS will not affect the implementation of the clearing requirement.
-
-

if a clearing member so requests, maintain separate records and accounts for the clearing
member’s clients and their clients’ clients (i.e. the indirect clients) in a manner that satisfies Art.
39(9) EMIR2;and

provide certain support to a clearing member in relation to the default of a client providing
indirect clearing services.
Clearing members have no obligation to facilitate indirect clearing arrangements. If a clearing member
elects to facilitate indirect clearing arrangements:

such indirect clearing arrangements must be on reasonable commercial terms;

the clearing member must publicly disclose the general terms of the contractual arrangements
(but without prejudice to the confidentiality of such arrangements);

the clearing member must maintain separate records and accounts enabling a client to
distinguish either (i) the assets and positions of the client from those held for the accounts of its
indirect clients or (ii) the assets and positions of held for the account of an indirect client from
those held for the account of other indirect clients, as instructed by its client, in a manner that
satisfies Art. 39(9) EMIR;

the clearing member will be obliged to identify, monitor and manage any risks that might arise
from facilitating indirect clearing arrangements;

the clearing member must establish “robust procedures” to cope with the default of a client that
provided indirect clearing services, including (i) a credible mechanism for transferring the
positions and assets to an alternative client or clearing member (subject to the agreement of the
relevant indirect clients) and (ii) a mechanism for the prompt liquidation of indirect clients’
assets and positions; and

the clearing member must have a robust internal procedure to safeguard any information
provided to it by a client for the purposes of managing risk.
The client of a clearing member that wishes to offer indirect clearing to its clients must:

be an authorised credit institution or investment firm (or a third-country equivalent);

consult with the clearing member on the aspects that may impact the operations of the clearing
member;

include an obligation on the client, in the agreement between the client and the indirect client, to
honour all obligations of the indirect client towards the clearing member (that arise from the
indirect clearing arrangement);

keep separate records and accounts for themselves and for the indirect clients in a manner that
satisfies Art. 39(9) EMIR;

offer the indirect clients a choice of segregation options and keep the indirect clients fully
informed of the risks thereof;

ask the clearing member to open a segregated account at the CCP for holding the assets and
positions of its indirect clients; and

provide information to the clearing member that allows the clearing member to identify, monitor
and manage any risks arising as a result of facilitating indirect clearing.
The client will not be required to disclose information on individual indirect clients, except for the purposes of
managing risk (see above) or in the event that the client defaults, in which case the client must immediately pass
all the information in respect of the indirect clients to the clearing member.
2
i.e. where (a) the assets and positions are recorded in separate accounts; (b) the netting of positions recorded on different
accounts is prevented; and (c) the assets covering the positions recorded in an account are not exposed to losses connected to
positions recorded in another account.
2. RTS specifying the details that competent authorities (e.g. national regulators) should send
to ESMA when applying to make a class of OTC derivatives subject to the mandatory clearing
obligation under the ‘bottom-up’approach’ (Art. 5 EMIR.)
The “bottom-up” approach to applying the clearing obligation is where a CCP decides to begin clearing a new
class of OTC derivative transaction and applies to its national regulator for authorisation to do so. If the national
regulator grants such authorisation, it shall also inform ESMA; and ESMA will then decide whether all such
transactions must be subject to a mandatory clearing obligation. Although Article 5 EMIR anticipates that the
national regulator will supply ESMA with information on which to make a decision, in practice ESMA have moved
the burden for obtaining the information on to the CCPs.
CCPs will have to supply to the national regulators (who will then pass on to ESMA) the following:
-
the identification of the class of OTC derivatives, and the type of transactions within the class;
-
other information about the transactions that ESMA will need to include in the public register, such as the
asset
-
class, the underlying(s), the notional and settlement currencies, settlement conditions, range of
maturities, range of
-
payment frequency, and the product identifier;
-
any other information needed in order to distinguish the type of transactions affected;
-
evidence of standardisation, including data on the daily reference price;
-
volume data, including the number of transactions, total volume, total open interest, depth of orders,
average number of orders and requests for quotes, and tightness of spread;
-
liquidity data, including measures of liquidity under stressed market conditions and for the executive of
default procedures;
-
evidence of the availability of reliable pricing information;
-
evidence of the ability of CCPs to handle the expected volume of transactions, and to manage the risk
arising from them;
-
details of what tasks would be done in order to prepare for clearing these transactions, with estimates of
the time involved; and
-
evidence of the potential impact of the clearing obligation on:

the availability of reliable pricing information;

the expected volume of OTC derivatives transactions in that class;

the type and number of counterparties active in the market for that type of transaction; and

the effect on the risk management, legal and operational capacity of the counterparties active.
This information will be published by ESMA in the public register (which is intended to put market participants in a
position to prepare for compliance with a potential clearing obligation). The recitals to the final RTS acknowledge
that, for new derivatives products, specific historical data might not always be available.
3. RTS specifying the criteria that ESMA will assess when deciding whether or not to extend
the clearing obligation to a new class of OTC derivatives in order to reduce systemic risk (Art.
5(4) EMIR.)
The criteria set out in EMIR as developed by ESMA, are as follows. ESMA must take into consideration:
-
The degree of standardisation of contractual terms (Art. 5(4)(a) EMIR), including the incorporation of
common legal documents such as master netting agreements, the use of standard terms, definitions,
and confirmations which set out specifications commonly used by counterparties (Art. 6(1)(a) of the final
RTS).
-
The degree of standardisation of operational processes (Art. 5(4)(a) EMIR), including whether they
are subject to automated post-trade processing and lifecycle events “managed in a common manner”
and to a widely-agreed timetable (Art. 6(1)(b) of the final RTS).
-
The volume and liquidity of the relevant class of derivatives (Art. 5(4)(a) EMIR), including whether or
not the margins or financial requirements of the CCP are proportionate to the risks, the stability and
market size and depth of the class, the effect of clearing member default on market dispersion, and the
number and value of transactions (Art. 6(2)(a)-(d) of the final RTS).
-
The availability of reliable pricing information (Art. 5(4)(c) EMIR), including whether or not this
information is easily accessible to market participants on a reasonable commercial basis, and whether
this would be affected by the clearing obligation (Art. 6(3) in the final RTS).
4. RTS specifying the notion of liquidity fragmentation (Art. 8(5) EMIR.)
Art. 8 EMIR provides that a trading venue is required to provide trade feeds on a non-discriminatory basis to any
CCP that requests them and which is authorised to clear the relevant class of OTC derivatives. This access is
subject to the condition that it does not “threaten the smooth and orderly functioning of markets in particular due
to liquidity fragmentation”. Liquidity fragmentation occurs where parties on a trading venue are unable to
conclude a transaction because they do not all have access to the same clearing arrangements. To avoid this
situation, Art. 8 of the final RTS provides that before a new CCP can join a trading venue, they must put in place
safeguards to make sure that everyone on the trading venue has access to at least one CCP in common (possibly
through indirect clearing arrangements) or some other arrangement established by the CCPs, such as
transferring transactions to the clearing members of other CCPs. However the draft final RTS makes clear that
clearing members of the original CCP should not be forced to become clearing members of the new CCP in order
to complete a transaction.
5. RTS specifying the details of OTC derivatives transactions that counterparties need report
to TRs, as well as the format, frequency, etc., of such reports (Art. 9(5)-(6) EMIR.)
The following data must be supplied by each of the counterparties (or their delegates) separately:
1. Date and time of the reporting
2. Reporting counterparty’s unique
ID code
3. Other counterparty’s unique ID
code
4. Name of counterparty
5. Full address of counterparty
6. Corporate sector of counterparty
(e.g. bank, insurance company,
etc.)
7. Is it a financial or non-financial
counterparty (according to EMIR)?
8. Counterparty’s broker’s unique
ID code (if applicable)
9. Reporting entity’s ID
10. Clearing member’s ID
11. Beneficiary’s unique ID (if the
counterparty is not the beneficiary
to the contract)
12. Whether contract was executed
on counterparty’s own account or
for the account of/on behalf of a
client.
13. Whether the reporting
counterparty was buying or selling
14. Whether the counterparty was
trading with a non-EEA
counterparty
15. (For non-financial
counterparties) was the contract
directly linked to commercial or
treasury financing activity (c.f. the
EMIR clearing threshold)?
16. (For non-financial
counterparties) is the counterparty
above the EMIR clearing threshold?
17. Mark-to-market value of the
contract
18. Currency of mark-to-market
valuation
19. Valuation date
20. Valuation time
21. Valuation type, e.g. mark-tomarket or mark-to-model
22. Whether or not the contract is
collateralised
23. (If collateralised) whether there
is a collateral portfolio
24. (If collateral portfolio) collateral
portfolio code
25. (If collateralised) value of the
collateral
26. (If collateralised) currency of the
collateral valuation
The following data can be supplied by just one of the counterparties (or their delegate). The list below is taken
from the final RTS, but incorporates some of the notes from the 25 June draft RTS where applicable:
1. Taxonomy of the reported
contract.
2.-3. Unique product ID.
4. Unique ID for any underlying
instruments (including baskets or
indices)
5.-6. Notional currency
7. Deliverable currency
8. Internationally agreed trade ID
9. Transaction reference number.
10. Unique ID of trading venue (or
note that it was concluded OTC)
26. Date and time of confirmation
27. Whether contract was
electronically confirmed/nonelectronically
confirmed/unconfirmed
28. Whether reported contract is
subject to the clearing obligation.
29. Whether clearing has taken
place.
30. (If cleared) Time and date of
clearing
31. (If cleared) CCP’s unique ID
45. (For commodity derivatives)
name of the commodity base, e.g.
agriculture or metals.
46. (For commodity derivatives)
details of the particular commodity,
e.g. livestock or oil
47. (For commodity derivatives)
delivery point or zone: physical or
virtual point where the delivery
takes place
48. (For commodity derivatives)
interconnection point
11. Does the contract result from
compression?
12. Price/rate per derivative.
13. Price notation
14. Notional amount: face value of
the contract, value of the
deliverables
15. Price multiplier: no. of
derivatives represented by one
contract.
16. Quantity: no. of contracts
included in the contract
17. Amount of any up-front
payment
18. Delivery type: whether the
contract is settled physically or In
cash
19. Time and date the contract was
executed or modified
20. Date when obligations under
the contract come into effect
21. Maturity date: date when
contract expires/exercise date.
22. Termination date (if different
from maturity date)
23. Date of settlement of the
underlying
24. Master agreement type (if
applicable).
25. Master agreement version date
(if applicable)
code.
32. Whether contract part of an
intra-group transaction.
33.-34. (For interest rate
derivatives) level of the fixed rate
leg
35. (For interest rate derivatives)
fixed rate day count fraction: actual
number of days in the relevant fixed
rate payer calculation period.
36. (For interest rate derivatives)
frequency of payments for the fixed
rate leg
37. (For interest rate derivatives)
frequency of payments for the
floating rate leg
38. (For interest rate derivatives)
frequency of floating rate leg resets
39-40. (For interest rate derivatives)
name of floating rate index
41. (For currency derivatives) the
cross currency, as different from the
currency of delivery (#4).
42. (For currency derivatives)
exchange rate 1, at the moment of
the conclusion of the contract
43. (For currency derivatives)
forward exchange rate, at the
moment of the conclusion of the
contract
44. (For currency derivatives)
exchange rate basis; e.g. EUR/USD
or USD/EUR
49. (For commodity derivatives)
load type: product delivery profile:
baseload, peak, off-peak, block
hours or other
50. (For commodity derivatives)
delivery start date and time
51.(For commodity derivatives)
delivery end date and time
52.(For commodity derivatives)
contract capacity
53.(For commodity derivatives)
quantity unit
54.(For commodity derivatives)
price/time interval quantities
55. (For options contracts) whether
the option is a put or a call (from
the counterparty’s perspective)
56. (For options contracts) whether
the option can be exercised only on
a fixed date, or at any time in the
life of a contract; i.e. American,
Bermudan, European or Asian
style.
57. (For options contracts) strike
price of the option
58. Whether the report is new,
modifying details of a previouslyreported contract, cancelling a
trade, or making some other
amendment
59. Details of the action type.
In the accompanying consultation paper, ESMA hinted that, in spite of calls to harmonise reporting requirements
under REMIT, MiFID and EMIR (so that parties would only need to send one set of reports to a joint EMIR Trade
Repository/MiFID Approved Reporting Mechanism in order to discharge all their regulatory reporting obligations),
this might not happen any time soon (although ESMA will “continue working towards the objectives”).
6. RTS setting the criteria for applying the clearing threshold exemption for OTC derivative
transactions held by non-financial parties for the purposes of hedging (etc.) alone (Art. 10(4)(a)
EMIR.)
An OTC derivative transaction will fall into the Art. 10(3) EMIR exemption (and so will not be taken into account
for the purposes of determining whether the clearing threshold in relation to a non-financial counterparty has been
exceeded) if:
-
-
it covers the risks arising from:

the potential change in the value of assets, services, inputs, products, commodities or liabilities that
the non-financial counterparty or its group owns, produces, manufactures, processes, provides,
purchases, leases, sells or incurs or reasonably anticipates owning, producing, manufacturing,
processing, providing, purchasing, merchandising, leasing, selling or incurring in the normal course
of its business; or

the potential indirect impact on the value of assets, services, inputs, products, commodities or
liabilities referred to in subparagraph (a), resulting from fluctuation of interest rates, inflation rates,
foreign exchange rates or credit risk; or
it qualifies as a hedging transaction under the International Financial Reporting Standards.
An OTC derivatives transaction can meet the conditions above either by itself or in combination with other OTC
derivatives transactions. Proxy hedging, portfolio hedging and offsetting hedges are all permitted, as long as they
meet the criteria above. In addition, OTC derivative transactions connected with hedging employee benefits
(such as stock options), company credit risk, and the acquisition of other companies, will all fall within the criteria.
7. RTS setting the values of the clearing threshold (Art. 10(4)(b) EMIR.)
The clearing thresholds in Article 10 of the final RTS are:
Type of OTC derivatives transaction
Gross notional
value
Credit derivatives
€1bn
Equity derivatives
€1bn
Interest rate derivatives
€3bn
Foreign exchange derivatives
€3bn
Commodity derivatives and other OTC derivative
transactions
€3bn
When a non-financial counterparty reaches the clearing threshold for one of the asset classes above, it is
considered to have exceeded the clearing threshold. In this case, the non-financial counterparty is subject to the
clearing obligation for all classes of OTC derivatives transactions (that are themselves subject to the clearing
obligation), and not just the class for which they exceeded the clearing threshold. ESMA considered that using
the notional value of an OTC derivatives transaction (rather than the mark-to-market) was simpler for
counterparties to monitor and calculate. The clearing thresholds will be reviewed by ESMA on a regular basis.
8. RTS specifying the procedures and arrangements that counterparties must introduce “to
measure, monitor and mitigate … risk” when entering into non-centrally cleared OTC
derivatives transactions (Art. 11(14)(a) EMIR.)
Art. 11(1) EMIR provides that the risk management procedures for non-cleared OTC derivatives must include, at
the very least, arrangements for timely confirmation, portfolio reconciliation, dispute resolution, and for monitoring
the value of the outstanding transactions. Please see the section below for details on valuation.
-
Timely confirmation: all OTC derivatives transactions not cleared by a CCP must be confirmed as soon
as possible, although the absolute final deadlines for confirmation differ depending on the
circumstances:
Counterparties
Derivatives
Deadline for confirmation
Concluded between financial
counterparties, or nonfinancial counterparties over
the clearing threshold
Credit default
swaps (‘CDS’)
and interest rate
swaps (‘IRS’)
(Until 28 Feb 2014) by the end of the second
business day following execution;
As above
All OTC
derivatives
transactions other
than CDS and IRS
(Until 31 Aug 2013) by the end of the third
business day following execution;
(From 28 Feb 2014) by the end of the next
business day following execution.
(From 31 Aug 2013 until 31 August 2014) by the
end of the second business day following
execution;
(From 31 August 2014) by the end of the
business day following execution.
Concluded with a financial
counterparty under the
clearing threshold
CDS and IRS
(Until 31 Aug 2013) by the end of the fifth
business day following execution;
(From 31 Aug 2013 to 31 Aug 2014) by the end of
the third business day following execution;
(From 31 Aug 2014) by the end of the second
business day following execution.
As above
All OTC
derivatives
transactions other
than CDS and IRS
(Until 31 Aug 2013) by the end of the seventh
business day following execution;
(From 31 Aug 2013 to 31 Aug 2014) by the end of
the fourth business day following execution;
(From 31 Aug 2014) by the end of the second
business day following execution.
Where an OTC derivatives transaction is concluded after 4pm local time, or with a counterparty in a different time
zone which does not allow confirmation by the set deadline, each of the above deadlines are extended by one
additional business day.
Confirmation must be made electronically, and where possible and may be delegated. Financial counterparties
must introduce procedures for reporting to a competent authority every month the number of OTC derivatives
transactions which remain unconfirmed for more than five business days following the relevant trade date.
-
Portfolio reconciliation: both counterparties must agree in writing on the terms for reconciling portfolios
before entering an OTC derivatives transaction. The reconciliation must cover the key trade terms that
identify each individual transaction, and must include at least the daily mark-to-market valuation of the
OTC derivatives transaction (subject to the exception below for circumstances permitting mark-to-model
valuation). The frequency with which counterparties must perform portfolio reconciliation depends on the
number of outstanding OTC derivatives transactions there are between them:
Counterparties
Number of outstanding
OTC derivatives
transactions
When they must reconcile
Financial counterparty, or non-financial
counterparty over the clearing threshold
500 or more:
each business day
As above
51 to 499:
once a week
As above
Less than 50:
once every three months
Non-financial counterparty under the
clearing threshold
101 or more:
once every three months
As above
100 or less:
once per year
Counterparties with 500 or more OTC derivatives transactions outstanding which are not centrally cleared should
conduct a portfolio compression exercise at least twice a year, in order to reduce counterparty credit risk.
Alternatively, they should at least analyse the possibility of doing so, and be able provide a reasonable
explanation of why a portfolio compression exercise was not appropriate.
-
Dispute resolution: counterparties must agree on a procedure for recording the details (parties,
amount, length) of disputes relating to recognition or valuation of the OTC derivatives transaction or the
exchange of collateral. They must also have procedures for resolving disputes in a timely manner,
including “specific processes” for disputes not resolved within five days.
Financial counterparties must report to their competent authority any dispute relating to an OTC
derivatives transaction, its valuation or the exchange of collateral for an amount or a value higher than
EUR15,000,000 that is outstanding for at least 15 business days.
9. RTS specifying the market conditions in which marking-to-model should be used instead of
marking-to-market the value of non-centrally cleared OTC derivatives (Art. 11(14)(b) EMIR.).
Where the market is inactive (i.e. when quoted prices are not readily available, and the prices that are available
do not represent actual, regular, arms-length transactions) then mark-to-model valuation shall be used instead of
mark-to-market. Marking-to-model shall also be used where there are a significant range of estimates for
reasonable fair value, and the probabilities of the various estimates cannot reasonably be assessed.
ESMA have developed various criteria that any marking-to-model must fulfil. It must:
-
incorporate all the factors that counterparties would consider in setting a price, using as much mark-tomarket information as possible;
-
be consistent with accepted economic methodologies;
-
be calibrated against any current market activity;
-
be independently monitored and validated; and
-
be documented and approved by the board at least annually (though this may be delegated to a
committee).
10. RTS specifying the information that parties must pass on to the national regulators when
relying on the exemption for intragroup transactions, and what information they should
publicly disclose (Art. 11(14)(c)-(d) EMIR.).
By way of reminder, Art. 11(5) EMIR exempts intragroup OTC derivatives transactions where both counterparties
are based in the same member state, from the requirement that both financial counterparties and non-financial
counterparties over the clearing threshold, that conduct transactions in non-centrally cleared OTC derivatives
transactions, shall “have risk management procedures that require the timely, accurate and appropriately
segregated exchange of collateral” for such transactions.
In respect of intragroup OTC derivatives transactions where both counterparties are not based in the same
member state, in order to rely on a total or partial exemption from such requirement, the parties will either need to
apply to the national regulator(s) in advance of entering into the relevant transaction, or else notify them after
entering into the relevant transaction, depending on the type and location of the counterparties:
Counterparty 1
Counterparty 2
Apply before or notify after?
Financial counterparty
Financial counterparty in
different Member State
Apply to both states’ national regulators beforehand
Non-financial
counterparty
Non-financial counterparty in
different Member State
Notify both states’ national regulators afterwards
Financial counterparty
counterparty in third country
jurisdiction
Apply to CP 1’s national regulator beforehand
Non-financial
counterparty
counterparty in third country
jurisdiction
Notify CP 1’s national regulator beforehand
Financial counterparty
Non-financial counterparty in
different Member State
Apply to the Financial CP’s national regulator
beforehand
Whether a party is applying beforehand or notifying after entering into the relevant OTC derivatives transaction, it
must notify their national regulator in writing, and provide the following information:
- The legal counterparties;
- Unique identifier codes;
- Corporate relationship;
- Contractual relationship;
- Category of intragroup relationships in Art. 3(1)-(2) EMIR they fall under:

a contract with another member of the same group included in the same consolidation on a full
basis, subject to risk evaluation etc., and established in the Union or in a recognised, equivalent
third country;

a contract between a financial counterparty and another financial counterparty, financial holding
company, financial institution or ancillary services undertaking subject to prudential requirements,
3
which is part of the same institutional protection scheme ; or

a contract between two credit institutions affiliated to the same central body, or between a credit
institution and the central body4,
- Details of the OTC derivatives transaction for which they are seeking an exemption, including:
- the asset class of OTC derivative contracts;
- the type of OTC derivative contracts;
- the type of underlyings;
- the notional and settlement currencies;
- the range of contract tenors;
- the settlement types;
- the anticipated sizes, volumes and frequency of OTC derivative contracts per annum; and
- evidence of adequately sound risk management and a lack of practical or legal impediments.
As part of its application or notification to the relevant competent authority, a counterparty must also submit
supporting information evidencing that:
-
its risk-management procedures are adequately sound, robust and consistent with the level of
complexity of the transaction; and
-
there is no current or foreseen practical or legal impediment to the prompt transfer of own funds or
repayment of liabilities between the counterparties.
The supporting documents shall include copies of documented risk management procedures, historical
transaction information, copies of the relevant contracts between the parties and may include a legal opinion upon
request from the competent authority.
When a counterparty applies for an intra-group exemption it must also publicly disclose the following information
(to ensure transparency vis-à-vis market participants and potential creditors):
3
4
-
the legal counterparties;
-
their unique identifier codes;
-
their corporate relationship;
-
whether they have been granted a full or partial exemption; and
c.f. Article 80(8) of the recast Banking Directive, 2006/48/EC.
c.f. Article 3(1) of the recast Banking Directive, 2006/48/EC.
-
the notional aggregate amount of the OTC derivative transactions for which the intragroup exemption
applies.
Other RTS
Although due by 30 September 2012, ESMA did not have time to prepare RTS specifying:
1)
which contracts between third country entities are “considered to have a direct, substantial and
foreseeable effect within the EU” (or are otherwise necessary to regulate in order to prevent
evasion) and, as such, should be subject to EMIR. (Art. 4(4) EMIR);
2)
the risk management procedures (including collateral segregation) required for transactions in noncentrally cleared OTC derivatives by financial counterparties (and non-financial counterparties over
5
the clearing threshold) (Art. 11(15)(a) EMIR) ;
3)
the capital requirements for financial counterparties dealing in non-centrally cleared OTC derivatives
(Art. 11(15)(b) EMIR)**;
4)
**
the procedures for applying for the Art. 11 EMIR intragroup exemption (Art. 11(15)(c) EMIR) ; or
5)
the criteria that the national regulators should use in deciding whether to grant an application for the
**
exemption (Art. 11(15)(c) EMIR) ;
and are waiting on the EC to assign them a new deadline for these.
According to the EMIR FAQ published by ESMA on 19 November 2012, RTS (1) above is “still under review”;
while RTS (2) and (3) have been delayed “because further international coordination is necessary on this topic
before EU rules can be developed”. Nothing further has been published at the time of writing.
The Future
As noted in the introduction (‘Update’), the RTS and ITS were adopted by the EC without modification6 on 19
December 2012.
The ITS are not subject to a right of scrutiny, and so were published in the Official Journal on 21 December,
taking legal effect on 10 January 2013. The ITS only contain technical provisions that complement the RTS,
however, and so nothing will actually happen on this date, in practice.
The RTS were sent to the European Parliament and Council of the European Union for legislative scrutiny. This is
typically for a period of one month, but as was just before the Christmas holidays, the EP applied for a one-month
extension to 19 February 2013.
In January 2013 there were news reports that the European Parliament was considering rejecting the ESMA RTS,
on the grounds that the clearing threshold for non-financial counterparties was set too low, and that it was wrong
for the calculation to make no distinction between different classes of OTC derivatives contract. There were also
possibly broader concerns with the ‘volumetric’ approach to imposing the clearing obligation on non-financial
counterparties
The Economics and Monetary Affairs Committee of the European Parliament (‘ECON’) passed a resolution
requiring a formal reevaluation of the rules. On 7 February 2013, however, Commissioner Barnier made a
statement that the ECON resolution had now been withdrawn, and that the RTS were to be adopted without
objection. They are now backon schedule to come into force mid-March.
For precise implementation details, please see below.
Clearing Obligation
Within six months of the RTS entering into force, CCPs providing clearing services must apply for authorisation or
(in the case of third-country CCPs) recognition. Existing CCPs can continue to operate during the interim period.
Within six months of a CCP being authorised or recognised, EMIR will determine whether the classes of OTC
derivatives contracts that the CCP is able to clear should be made subject to the clearing obligation. At the same
5
6
To be jointly prepared with the European Banking Authority and the European Insurance and Occupational Pensions Authority.
With one exception – see ‘Update’, above.
time, ESMA will decide the date on which the clearing obligation comes into force for that class of OTC
derivatives contracts.
ESMA expects to begin making these assessments in the first quarter of 2013, with the first clearing obligations
entering into force shortly afterwards.
Reporting Obligation
The reporting obligation will be phased-in over time, based on asset class and whether or not there is a trade
repository authorised for that class yet:
Derivative class
Trade repository authorised for that class?
When?
Reporting obligation start date:
CDS and IRS
Yes; TR registered before 1 April 2013
1 July 2013
As above
Yes; TR registered between 1 April 2013 and
1 July 2015
90 days after a TR is registered for that
class
As above
No TR registered by 1 July 2015
1 July 2015 (contracts reported to ESMA)
All other OTC
derivatives
Yes; TR registered before 1 October 2013
1 January 20147
As above
Yes, TR registered between 1 October 2013
and 1 July 2015
90 days after a TR is registered for that
class**
As above
No TR registered by 1 July 2015
1 July 2015** (contracts reported to ESMA)
OTC derivatives transactions outstanding on 16 August 2012 and still outstanding on the reporting obligation start
date must be reported within 90 days of that date. OTC derivatives transactions outstanding on 16 August 2012
and no longer outstanding at the time of the reporting obligation start date need only be reported within three
years of that date.
Exceptions
The rules on:
-
portfolio reconciliation (Art. 12);
-
portfolio compression (Art. 13); and
-
dispute resolution (Art. 14),
will only begin to apply six months after the rest of the RTS comes into force.
Note also that several RTS are still pending (see ‘Other RTS’, above) and so will not adhere to the timeframe
above. These include RTS specifying the risk management procedures and additional collateral requirements for
non-centrally cleared OTC derivatives contracts.
7
Or whichever of these is the earlier
Contacts
Ash Saluja
Jason Harding
Partner
T: +44 (0)20 7367 2734
E: ash.saluja@cms-cmck.com
Partner
T: +44 (0)20 7367 3138
E: jason.harding@cms-cmck.com
Will Dibble
Michael Cavers
Partner
T: +44 (0)20 7367 3378
E: will.dibble@cms-cmck.com
Partner
T: +44 (0)20 7367 3413 E:
michael.cavers@cms-cmck.com
25 July 2013
204604710
This report is for general purposes and guidance only and does not constitute legal or professional advice and should not be relied on or treated
as a substitute for specific advice relevant to particular circumstances. For legal advice, please contact your main contact partner at the relevant
CMS member firm. If you are not a client of a CMS member firm, or if you have general queries about Law-Now or RegZone, please send an
email to: law-now.support@cmslegal.com so that your enquiry can be passed on to the right person(s).
All Law-Now and RegZone information relates to circumstances prevailing at the date of its original publication and may not have been updated to
reflect subsequent developments.
CMS Legal Services EEIG (CMS EEIG), has its head office at: Barckhausstraße 12-16, 60325 Frankfurt, Germany. The contact email address for
CMS EEIG is info@cmslegal.com, its Ust-ID is: DE 257 695 176 and it is registered on Handelsregister A in Frankfurt am Main with the
registration number: HRA 44853. CMS Legal Services EEIG (CMS EEIG) is a European Economic Interest Grouping that coordinates an
organisation of independent law firms. CMS EEIG provides no client services. Such services are solely provided by CMS EEIG’s member firms in
their respective jurisdictions. CMS EEIG and each of its member firms are separate and legally distinct entities, and no such entity has any
authority to bind any other. CMS EEIG and each member firm are liable only for their own acts or omissions and not those of each other. The
brand name “CMS” and the term “firm” are used to refer to some or all of the member firms or their offices.
CMS EEIG member firms are:
CMS Adonnino Ascoli & Cavasola Scamoni, Associazione Professionale (Italy); CMS Albiñana & Suárez de Lezo S. L. P. (Spain); CMS Bureau
Francis Lefebvre S. E. L. A. F. A. (France); CMS Cameron McKenna LLP (UK); CMS China (China); CMS DeBacker SCRL / CVBA (Belgium);
CMS Derks Star Busmann N. V. (The Netherlands); CMS von Erlach Poncet Ltd (Switzerland); CMS Hasche Sigle Partnerschaft von
Rechtsanwälten und Steuerberatern mbB (Germany); CMS Reich-Rohrwig Hainz Rechtsanwälte GmbH (Austria); CMS Russia and CMS Rui
Pena, Arnaut & Associados RL (Portugal).
For more information about CMS including details of all of the locations in which CMS operates please visit: www.cmslegal.com.
© CMS Legal 2015. All rights reserved.
EMIR: key facts about the margining of non-cleared OTC derivative
transactions
Background
EMIR (European Market Infrastructure Regulation No. 648/2012) requires that certain counterparties (please see
below) to OTC derivative transactions not cleared through a central counterparty (non-cleared OTC
transactions) put in place risk management procedures for “the timely, accurate and appropriately segregated
exchange of collateral” in order to reduce counterparty credit risk. This requirement is commonly referred to as
“margining” and applies to counterparties classified as (i) financial counterparties (FCs); or (ii) non-financial
counterparties over the clearing threshold (as specified in Art. 11 of Regulation No. 149/2013) (NFC+s, and
together with FCs, the FC/NFC+ counterparties).
On 14 April 2014, the European Supervisory Authorities (ESAs) published common draft regulatory technical
standards (RTS) setting out details of the proposed regulatory framework on margining. The consultation period
with respect to these RTS ended on 14 July 2014. It is expected that the ESAs will submit the final draft RTS to
the European Commission by the end of 2014 with the intention that the majority of the margining arrangements
will enter into force as of 1 December 2015.
The arrangements proposed under the RTS include (i) implementing risk management procedures which include
the collection of collateral; (ii) various opt-outs from the requirement to exchange collateral; (iii) minimum eligibility
criteria for collateral; and (iv) robust operational procedures for the exchange of collateral. This note discusses
each of these arrangements in turn.
Collection of collateral
To prevent the build-up of uncollateralised exposures, FC/NFC+ counterparties will be required to collect
collateral in the form of initial margin and variation margin. This will apply whether or not their counterparty is
established in the EU, subject to the opt-outs outlined in section “Opt-out options” below.
Initial Margin
Initial margin will be collected “gross” (i.e., as a two-way payment without the possibility of netting initial margin
amounts against each other) within the business day following the entry into a non-cleared OTC transaction. The
idea is for initial margin to cover the potential future exposure of an FC/NFC+ counterparty due to its
counterparty’s default. Consequently, initial margin will need to be recalculated following a change to the portfolio
of non-cleared OTC transactions between the counterparties (e.g., due to the termination of any non-cleared OTC
th
transaction) and otherwise every 10 business day, in each case to reflect movements in counterparties’ risk
positions.
The RTS require that initial margin is segregated from proprietary assets of any third party custodian and that the
compliance by an FC/NFC+ counterparty with the requirements under the RTS on segregation is supported by
legal opinion(s) to be obtained at least annually. In addition, the RTS require that initial margin is not subject to
any rehypothecation or other reuse by a collecting FC/NFC+ counterparty.
Variation Margin
Variation margin will be collected “net” on a daily basis to reflect current exposures resulting from actual changes
in market price calculated in accordance with the daily valuation requirement under Art. 11(2) of EMIR.
Opt-out options
Various exceptions to the requirement to collect margin (initial margin, variation margin or both) will be available.
These exceptions are broadly as follows:

An FC/NFC+ counterparty may agree:
o
not to collect initial margin with respect to (i) physically-settled FX forwards; (ii) physically-settled FX
swaps; or (iii) the exchange of principal of a currency swap;
o
not to collect initial margin if it or its counterparty belongs to a consolidated group whose aggregate
month-end average notional amount of non-cleared OTC transactions for June, July and August of
the relevant year is below a certain threshold. The applicable threshold amounts are as follows:
From 1 December
2015
€3 trillion
2016
€2.25 trillion
2017
€1.5 trillion
2018
€0.75 trillion
2019 onwards

Threshold Amount
€8 billion
o
not to collect initial and variation margin with respect to non-cleared OTC transactions with (i) nonfinancial counterparties below the clearing threshold; and/or (ii) counterparties exempt from EMIR
(as specified in Art. 1(4) and (5) of EMIR); and
o
not to collect initial and variation margin if the total amount of margin to be exchanged in relation to
all non-cleared OTC transactions between it and its counterparty is equal to or lower than €500,000.
In addition, an FC may agree not to collect initial margin where the total initial margin calculated to be
exchanged for all non-cleared OTC transactions between counterparties at group level is equal to or
lower than €50 million.
Eligibility of collateral
A wide range of asset classes will be eligible as collateral, including cash, gold, various types of debt securities
and equities. Most asset classes will be subject to further conditions, such as credit quality assessments (using an
approved internal rating based approach or external ratings), haircuts and concentration limits (of 50%, 10% and
40% respectively, depending upon the asset class) to ensure sufficient diversity of collateral pools.
Operational procedures
A variety of operational requirements will be imposed on FC/NFC+ counterparties to ensure that the margining
arrangements are implemented in a manner which minimises any potential operational risks. Among other things,
the RTS highlight the need for (i) detailed policy documentation with regards to the exchange of collateral; (ii)
transparent senior management reporting of material exceptions; (iii) escalation procedures (both internally and
between the respective counterparties); (iv) processes to verify the liquidity of collateral; and (v) annual testing of
operational procedures for the exchange of collateral.
Contacts
Jason Harding
Partner, Financial Services and Products
T: +44 (0) 20 7367 3138
E:jason.harding@cms-cmck.com
Eva Valentova
Senior Associate, Financial Services and Products
T: +44 (0) 20 7367 3738
E:eva.valentova@cms-cmck.com
16 October 2014
This note is for general purposes and guidance only and does not constitute legal or professional advice and should not be relied on or treated as
a substitute for specific advice relevant to particular circumstances. For legal advice, please contact your main contact partner at the relevant CMS
member firm. If you are not a client of a CMS member firm, or if you have general queries about Law-Now or RegZone, please send an email to:
law-now.support@cmslegal.com so that your enquiry can be passed on to the right person(s).
All Law-Now and RegZone information relates to circumstances prevailing at the date of its original publication and may not have been updated to
reflect subsequent developments.
CMS Legal Services EEIG (CMS EEIG), has its head office at: Barckhausstraße 12-16, 60325 Frankfurt, Germany. The contact email address for
CMS EEIG is info@cmslegal.com, its Ust-ID is: DE 257 695 176 and it is registered on Handelsregister A in Frankfurt am Main with the
registration number: HRA 44853. CMS Legal Services EEIG (CMS EEIG) is a European Economic Interest Grouping that coordinates an
organisation of independent law firms. CMS EEIG provides no client services. Such services are solely provided by CMS EEIG’s member firms in
their respective jurisdictions. CMS EEIG and each of its member firms are separate and legally distinct entities, and no such entity has any
authority to bind any other. CMS EEIG and each member firm are liable only for their own acts or omissions and not those of each other. The
brand name “CMS” and the term “firm” are used to refer to some or all of the member firms or their offices.
CMS EEIG member firms are:
CMS Adonnino Ascoli & Cavasola Scamoni, Associazione Professionale (Italy); CMS Albiñana & Suárez de Lezo S. L. P. (Spain); CMS Bureau
Francis Lefebvre S. E. L. A. F. A. (France); CMS Cameron McKenna LLP (UK); CMS China (China); CMS DeBacker SCRL / CVBA (Belgium);
CMS Derks Star Busmann N. V. (The Netherlands); CMS von Erlach Poncet Ltd (Switzerland); CMS Hasche Sigle Partnerschaft von
Rechtsanwälten und Steuerberatern mbB (Germany); CMS Reich-Rohrwig Hainz Rechtsanwälte GmbH (Austria); CMS Russia and CMS Rui
Pena, Arnaut & Associados RL (Portugal).
For more information about CMS including details of all of the locations in which CMS operates please visit: www.cmslegal.com.
© CMS Legal 2015. All rights reserved.
EMIR and its extra-territorial applicability
SUMMARY
To increase transparency in the OTC derivatives markets, the European Market Infrastructure Regulation
(“EMIR”) requires certain market participants (the “counterparties”) to centrally clear OTC derivative contracts of
specified types (the “clearing obligation”) or to apply risk mitigation techniques set out in Art. 11 of EMIR (the
“risk mitigation obligation”). Risk mitigation techniques include, amongst others, portfolio reconciliation, dispute
resolution, valuation and margining.
Importantly, the clearing obligation and the risk mitigation obligation extend to OTC derivative contracts where
both counterparties are established in one or more countries outside the EU (each, a “third country entity” or
“TCE”) and:
-
the relevant OTC derivative contract has “a direct, substantial and foreseeable effect“ within the EU; or
it is “necessary or appropriate” to prevent the evasion of any provisions of EMIR.
The above is commonly referred to as “extraterritoriality” and this note outlines its potential consequences and
current market developments.
GENERAL CONSIDERATIONS
TCE’s counterparty status
The clearing obligation and the risk mitigation obligation only attach to TCEs that would be subject to the relevant
obligation if established in the EU. Therefore, as with EU counterparties, the extent to which these obligations are
to apply to a TCE will be driven by determining (by analogy) its status under EMIR. Whilst the clearing obligation
is only imposed on counterparties classified as financial counterparties (“FCs”) or non-financial counterparties
over the clearing threshold (as specified in Art. 11 of Regulation No. 149/2013) (“NFC+s”), some of the risk
mitigation techniques also extend to all counterparties, including non-financial counterparties below the clearing
threshold (“NFC-s”).
Although not strictly in the context of extraterritoriality, the European Securities and Markets Authority (“ESMA”)
has expressed a view that status designations of TCEs should be assessed by counterparties in cooperation
together, taking into account the nature of the activities undertaken by the relevant TCE counterparty. As this is
not necessarily a clear-cut determination, the assumptions and conclusions drawn should be properly
documented. Ultimately, the onus is on the relevant TCE to correctly determine its status designation under
EMIR. In practical terms, counterparties are likely to seek representations regarding their TCE counterparty’s
status designation. If it is not possible to assess what a TCE’s status under EMIR would be, ESMA has concluded
that counterparties should assume that a TCE’s status designation is NFC+ and take approaches to reflect this.
Equivalence
The applicability of the clearing obligation and the risk mitigation obligation to TCEs should always be subject to
Art. 13 of EMIR which sets out principles to avoid duplicative or conflicting rules (the “equivalence regime”).
What is the thinking behind “equivalence”? At its simplest, its effect is meant to be that if at least one of the
counterparties to an OTC derivative contract is established in an “equivalent jurisdiction” (i.e., whose legal
arrangements are declared by the EU Commission as equivalent to the relevant requirements under EMIR), the
provisions of EMIR could be “disapplied” as that jurisdiction’s framework would allow for an outcome similar to
that of EMIR. As a result, only TCEs located in non-equivalent jurisdictions would need to ensure compliance with
any requirements of EMIR that apply in relation to their OTC derivative contracts.
However, the implementing acts on equivalence are still being developed by the EU Commission. To date, the EU
Commission has mandated ESMA to provide technical advice on the equivalence of the legal regimes in
Australia, Canada, Hong Kong, Japan, India, Singapore, South Korea, Switzerland and the United States. The EU
Commission has yet to make any equivalence decisions based on ESMA’s advice. At this point, there is little
clarity as to how the equivalence regime under EMIR will operate (and interact with related legislation – please
see below). Going forward, many practical questions will need to be answered as to how TCEs can safely settle
compliance issues relative to their derivative trading.
WHERE ARE WE NOW?
On 10 October 2014, the major provisions of regulatory technical standards (the “RTS”) on “the direct, substantial
and foreseeable effect of [OTC derivative contracts] within the Union and to prevent the evasion of rules and
obligations” came into force. Their central purpose is to shed light on what a “direct, substantial and foreseeable
effect” is meant to capture to ensure consistent application of the clearing obligation and risk mitigation obligation
in extraterritoriality scenarios.
We consider below the key features of these RTS and their impact on TCEs.
Direct, substantial and foreseeable effect
The RTS provide that an OTC derivative contract will have a “direct, substantial and foreseeable effect” within the
EU in the circumstances as follows:
-
Firstly, when at least one TCE has (with respect to such OTC derivative contract) the benefit of a
guarantee provided by an EU guarantor whose status is an FC (i.e., potentially holding a significant
market position). The thinking behind this is that a default of such TCE under such OTC derivative
contract would impact that EU guarantor - which would be obliged to assume the resulting liability thereby importing risks to OTC derivatives markets in the EU.
Such guarantee is to meet two cumulative thresholds in order to qualify. In broader terms, it must:
-
-
cover the liability under one or more OTC derivative contracts for an aggregated notional amount
of at least EUR 8 billion (or cover only a part of such liability, in which case the above threshold
amount is to be proportionally reduced); and
be at least equal to 5 per cent. of the EU guarantor’s total “current exposures” (as defined in the
Capital Requirements Directive) under OTC derivative contracts.
The RTS also require that the liability that arises from these OTC derivative contracts must itself at least
reach the set threshold. If not, such OTC derivative contracts would not be considered to have a “direct,
substantial and foreseeable effect” within the EU even where (i) the maximum amount of the guarantee
reaches (or exceeds) that threshold, and (ii) the threshold regarding the EU guarantor’s current
exposures is met.
Crucially, the applicability of both thresholds is to be assessed both at the time such OTC derivative
contract is entered into and on an ongoing basis. An OTC derivative contract can become covered by
the RTS after it has been entered into and so it follows that the clearing obligation or the risk mitigation
obligation may subsequently apply with respect to an OTC derivative contract after it has been entered
into, even if it has been entered into on the basis that these obligations will not apply.
-
Secondly, an OTC derivative contract will have a “direct, substantial and foreseeable effect” within the
EU, if it has been entered into by two TCEs through their branches located in the EU and these TCEs
would be FCs if established in the EU. This is to address the regulator’s concern that these branches
may control a significant share of the OTC derivatives markets in the EU and so the inapplicability of the
relevant EMIR rules with respect to OTC derivative contracts involving such branches could be a cause
of potential market disruptions. For example, activities of these branches could significantly influence
market liquidity due to their strong market position.
2
A possible implication of the above is that the clearing obligation or the risk mitigation obligation may extend to
TCE subsidiaries of FCs established in the EU (if at least one of them benefits from a guarantee provided by its
parent with respect to its OTC derivative contracts). However, the current market expectation is that it should be
the TCE with the guarantee (in collaboration with the FC guarantor) that are to be responsible to ensure
compliance with these obligations as these are the only entities that can assess whether the applicable thresholds
with respect to the guarantee have been met at any given time.
The fact that the RTS anticipate an ongoing assessment of the thresholds raises a number of issues – in
particular, pricing and valuation uncertainties (as a result of clearing obligation or risk mitigation obligation
(primarily margining) being potentially applicable in the future) and difficulties in ensuring compliance if the other
counterparty is not cooperative. The market practice around these issues (and possible mitigants) is yet to be
settled and so it is currently not clear how the OTC derivatives market will respond to changes brought in by the
RTS.
Evasion of rules
The RTS also establish cases where it is necessary to prevent the evasion of provisions of EMIR in the context of
OTC derivative contracts between two TCEs. Briefly, the RTS apply to an OTC derivative contract if the way in
which it has been concluded is considered (having regard to all relevant circumstances and arrangements related
to it) as having the avoidance of the application of EMIR as its primary purpose. If an OTC derivative contract
lacks a clear business rationale or economic justification, it could be taken as having defeated the object, spirit
and purpose of any provision of EMIR that would otherwise apply and, therefore, be considered to be “evasive”.
INDIRECT IMPACT
EMIR inevitably also “bites” in the event of cross-border transactions (i.e., where a TCE is transacting with an EU
counterparty). This is most obvious when it comes to the clearing obligation. EMIR makes it explicit that this
obligation applies with respect to OTC derivative contracts between an EU counterparty (which is an FC or an
NFC+) and a TCE which would be subject to this obligation if it were established in the EU (please see ‘TCE’s
counterparty status’ above). However, ensuring compliance is of lesser concern for a TCE as the prevailing view
across the OTC derivatives market is that the responsibility lies with an EU counterparty.
So far as the risk mitigation obligation is concerned, there is no such express authority in EMIR. Nevertheless,
ESMA has advised that this obligation applies in the above context even though the TCE “would not itself be
subject to EMIR” and it is an EU counterparty which is to take appropriate actions so that the relevant risk
mitigation techniques are employed with respect to the relevant OTC derivative contracts.
The position should not be any different when it comes to any other requirement imposed by EMIR. TCEs are in
practice required by their EU counterparties to agree arrangements ensuring compliance with EMIR - with EU
counterparties being unlikely to trade derivatives with TCEs refusing to cooperate.
Contacts
Jason Harding
Partner, Financial Services and Products
T: +44 (0) 20 7367 3138
E:jason.harding@cms-cmck.com
Eva Valentova
Senior Associate, Financial Services and Products
T: +44 (0) 20 7367 3738
E:eva.valentova@cms-cmck.com
18 November 2014
3
2022206286
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© CMS Legal 2014. All rights reserved.
4
THE CM
MS EM
MIR TE
EAM
The Capital Markkets and Deriv
vatives Group
p at CMS combines leading derivative s, clearing, regulatory and
d
insollvency experttise to advise
e on developm
ments in the clearing of OTC
O
derivativves, members
ship of centra
al
clearring houses, clearing
c
rules
s, collateral trransformation and regulato
ory change.
The team has a broad range of experie
ence in advis
sing clients on
o the impacct of EMIR, including the
e
nego
otiation of doccumentation with
w potential clearing mem
mbers, advising on the riskks and structure relating to
o
the d
documentation provided by various CC
CPs (such as LCH Clearne
et) and providding legal opinions relating
g
to the risk of insolvency of clea
aring memberrs.
The Capital Markkets and Deriv
vatives Group
p is currently
y assisting a wide
w
range oof clients as to
o the ongoing
g
ementation off EMIR, given
n the complexxity of the regulation and th
he regulatory technical sta
andards.
imple
CON
NTACTS IN
N LONDON
N
Jason Ha
arding
Partner
Financial Services & Prroducts
harding@cms--cmck.com
E: jason.h
T: +44 (0)) 207 367 313
38
Will Diibble
Partnerr
Financcial Services & Products
cmck.com
E: will.ddibble@cms-c
T: +44 (0) 207 367 3378
3
Ash Salujja
Partner
Financial Services & Prroducts
mck.com
E: ash.salluja@cms-cm
T: +44 (0)) 207 367 273
34
Emma Riddle
Partnerr
Bankinng
ma.riddle@cm
ms-cmck.com
E: emm
T: +44 (0) 207 367 2563
2
Eva Valen
ntova
Senior Associate
Financial Services & Prroducts
E: eva.vallentova@cmsscmck.com
m
T: +44 (0)) 207 367 373
38
Chris C
Clark
Associaate
Financcial Services & Products
E: chriss.clark@cms--cmck.com
T: +44 (0) 207 367 3446
3
ormation, including
g a list of our offic
ces, can be foundd at www.cms-cm
mck.com
Further info
© CMS Cam
meron McKenna LLP
L
2015.
Raj Bhattt
Lawyer
Financial Services & Prroducts
E: raj.bhatt@cms-cmckk.com
T: +44 (0)) 207 367 278
82
Kirsty Templar
Lawyerr
Financcial Services & Products
ms-cmck.com
m
E: kirstty.templar@cm
T: +44 (0) 207 367 21
2
Jo Benne
ett
Lawyer
Financial Services & Prroducts
nett@cms-cm ck.com
E: jo.benn
T: +44 (0)) 207 367 349
94
Juliet C
Chrispin
Lawyerr
Financcial Services & Products
et.chrispin@cm
ms-cmck.com
E: juliet
T: +44 (0) 207 367 2703
2
YOUR C
CONTACT
T IN PRAGU
UE
Pavla Kře
ečková
Partner
Head of lo
ocal Banking a
and Finance
E: pavla.k
kreckova@cm
ms-cmck.com
T: +420 296 798 877
ormation, including
g a list of our offic
ces, can be foundd at www.cms-cm
mck.com
Further info
© CMS Cam
meron McKenna LLP
L
2015.