The EMIR Regulations and Their Implications

Maria Chetcuti-Cauchi | 03 Mar 2014

Chetcuti Cauchi Lawyers


Malta EMIR 

Regulation (EU) No 648/2012 (the ‘Regulations’) of the European Parliament and of the Council, better known as the European Market Infrastructure Regulations (EMIR), sets out to increase stability within the over the counter (OTC) derivatives market. EMIR also has supplementary regulations on the technical standards of the EMIR obligations listing from (EU) No 148/2013 to EU No 153/2013 and (EU) No 1247/2012 to (EU) No 1249/2012. The EMIR regulations came into force on 16th August 2012 and the technical standard regulations on 15 March 2013.

Issues in the OTC derivatives market were highlighted during the financial crisis and thus EMIR is the final product of regulations that European Parliament and European Council published for this subject matter. EMIR highlights the efforts being made by the EU to safeguard financial markets from financial catastrophe in the future by introducing a number of steps to create more certainty and less financial hazard in this area.

The main obligations under EMIR are;

1.       Central clearing for certain classes of OTC derivatives

2.       Application of risk mitigation techniques for non-centrally cleared OTC derivatives

3.       Reporting to trade repositories

4.       Application for organizational, conduct of business and prudential requirements for CCPs

5.       Applications of requirements for trade repositories, including the duty to make certain data available to the public and relevant authorities.

Clearing Obligation

Counter parties will be subject to clear all OTC derivatives of specific classes that have been declared subject to the clearing, in accordance with article 5(2) (clearing obligation procedure) of the Regulations, if those contracts fulfil both of the following conditions;

1.       If they have been concluded in one of the following ways between;

·         two financial counterparties

·         a financial counterparty and an in-scope non-financial counterparty

·         two in-scope financial counterparties

·         a financial counterparty or an in-scope non-financial counterparty and a third country entity that would be subject to the clearing obligation if it were established in the EU.

2.       They are entered into either ;

·         On or after the date from which the clearing obligation takes effect

·         On or after the ESMA receives a notification from a competent authority that the competent authority has authorized a central counterparty clearing (CCP) to clear a class of OTC derivatives, but before the date from which the clearing obligation takes effect.

The clearing obligation procedure, article 5(2) of the Regulations, states that when a competent authority authorizes a CCP to clear a class of OTC derivatives, it shall notify the ESMA of this immediately. The classes of OTC derivatives subject to the clearing obligation shall be listed in a public register which will be available on the ESMA website. The register will consist of two types of information;

1.       The list of classes of OTC derivatives notified to ESMA. This part of the register will be published after the notifications are received by ESMA as part of the clearing obligation procedure in article 5(2) of the Regulations. 

2.       The list of classes subject to the clearing obligation. This list shall be published after a public consultation takes place (taking place 6 months after notification received as described in point 1) between ESMA and ESRB, and where appropriate the competent authorities of third countries.

Clearing exemptions are in place for certain intro-group transactions. An Intra group transaction has a different meaning for financial and non-financial counterparties but the basic requirements are the same;

·         They must be entered into with another counterparty which is part of the same group where the counterparties are included in the same consolidation full time,

·         They are subject to appropriate centralized risk procedures and,

·         are established in the EU or third country which the Commission has found to impose equivalent obligations

Risk management obligation

When financial and non-financial counterparties enter into an OTC derivative contract that is not cleared by a CCP, these counterparties shall exercise due diligence procedures and ensure that appropriate procedures and arrangements are in place to measure, monitor and mitigate the operational and credit risk, including at least the timely confirmation of OTC derivatives, by electronic means where possible, and processes to reconcile portfolios, manage associated risk, identify disputes early and try to resolve them and to monitor the value of outstanding contracts. The financial and non-financial counterparties must mark-to-market the value of outstanding contracts on a daily basis and where market conditions prevent marking to market, they will mark them to model. In addition, financial and non - financial counterparties are required to exchange collateral on a timely and accurate manner. If the other counterparty so requests, any collateral received must be recorded separately in their accounts. Where the risk management procedures of the counterparties are adequately sound, robust and consistent with the level of complexity of the derivative 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, intra-group transactions are exempt from this obligation. However, this exemption is subject to approval by the relevant competent authorities. Finally, financial counterparties must hold a proportionate amount of capital. The sub-regulations of EMIR, the regulatory technical standards, specify the procedures and arrangements that the counterparties shall have in place, the market conditions that prevent marking-to-market and the criteria for using marking-to-model, the details of the exempted intra group transactions and the capital requirement.

ESMA shall be regularly monitoring these OTC derivatives that will not be eligible for clearing, especially where particular classes of derivatives pose systemic risk.

Reporting to trade repositories

Reporting to trade repositories applies to both financial and non-financial counterparties and to all derivatives, whether they are subject to the clearing obligation or not. When a derivative contract is concluded, modified, or terminated, these details must be reported to a trade repository no later than the working day following such a conclusion, modification or termination. EMSA will keep a list of trade repositories which may be used, however if a trade repository is not available, the details must be reported to ESMA. The form and content of these reports is available on the EMIR sub-regulations, the regulatory technical standards.

Application for organizational, conduct of business and prudential requirements for CCPs

When a legal person that is established in the union intending to provide clearing services as a CCP, must be authorized to do so by its Member States’ competent authority. Along with the application, the CCP must provide all information necessary to the competent authority in order for the authority to be satisfied that the CCP has established all the necessary arrangement to meet the requirements to provide such services. Once the application is complete, the competent authority shall manage and chair a college to discuss the application and whether it will be approved or refused. The college will consist of;

1.       ESMA;

2.       the CCP’s competent authority;

3.       the competent authorities responsible for the supervision of

4.       the clearing members of the CCP that are established in the three Member States with the largest contributions to the default fund of the CCP on an aggregate basis over a one-year period; ( a default fund is set up by a CCP to limit its credit exposures to its clearing members)

5.       the competent authorities responsible for the supervision of trading venues served by the CCP;

6.       the competent authorities supervising CCPs with which interoperability arrangements have been established;

7.        the competent authorities supervising central securities depositories to which the CCP is linked;

8.       the relevant members of the ESCB responsible for the oversight of the CCP and the relevant members of the ESCB responsible for the oversight of the CCPs with which interoperability arrangements have been established;

9.       the central banks of issue of the most relevant Union currencies of the financial instruments cleared.

One authorization is granted, it shall be effective for the entire territory of the union. Authorization shall be granted only for the activities linked to clearing.

Applications of requirements for trade repositories

A trade repository shall be a legal person established in the union and it will submit an application for registration to ESMA. ESMA shall, within 40 working days from the notification, examine the application for registration based on the compliance of the trade repository and shall adopt a fully reasoned registration decision or decision refusing registration. ESMA shall publish on its website a list of trade repositories registered. That list shall be updated within five working days following the decision of acceptance.

There are a number of requirements for trade repository’s to follow in order for them be able to operate as a trade repository. A trade repository, in accordance with the regulations shall;

·         have robust governance arrange­ments, which include a clear organizational structure with well defined, transparent and consistent lines of responsibility and adequate internal control mechanisms, including sound admin­istrative and accounting procedures, which prevent any disclosure of confidential information.

·         maintain and operate effective written organizational and administrative arrangements to identify and manage any potential conflicts of interest concerning its managers, employees, or any person directly or indirectly linked to them by close links.

·         establish adequate policies and  procedures sufficient to ensure its compliance, including of its managers and employees, with all the provisions of the Regulation.

·         maintain and operate an adequate organizational structure to ensure continuity and orderly func­tioning of the trade repository in the performance of its services and activities. It shall employ appropriate and proportionate systems, resources and procedures.

·         maintain those ancillary services operationally separate from the trade repository’s function of centrally collecting and maintaining records of derivatives, when offering ancillary services such as trade confirmation, trade matching, credit event servicing, portfolio reconciliation or portfolio compression services

·         ensure that the senior management and members of the board of a trade repository  be fit and proper so as to ensure the sound and prudent management of the trade repository.

·         have objective, non-discriminatory and publicly disclosed requirements for access by undertakings  subject to the reporting obligation.

·          grant service providers non-discriminatory access to information maintained by the trade repository, on condition that the relevant counterparties have provided their consent. Criteria that restrict access shall only be permitted to the extent that their objective is to control the risk to the data maintained by a trade repository.

·         publicly disclose the prices and fees associated with services provided under this Regulation. It shall disclose the prices and fees of each service provided separately, including discounts and rebates and the conditions to benefit from those reductions. It shall allow reporting entities to access specific services separately. The prices and fees charged by a trade repository shall be cost-related.

·         regularly and in an easily accessible way, publish aggregate positions by class of derivatives on the contracts reported to it.

ESMA may require trade repositories and related third parties to whom the trade repositories have outsourced operational functions or activities to provide all information that is necessary.

Performance and cost related challenges

EMIR is not simply just a compliance regulation but a regulation that enforces upon asset managers new significant implications to operations, investment and overall strategies. Asset managers will now have to make changes to various processes and systems interfaces, for example posting collateral on an ongoing basis is a now procedure under EMIR and this is likely going to be time-costly for the asset manager. The introduction of a CCP to OTC derivative trading is likely to not only increase costs for asset managers but also but also change their strategies on account holding. The feel models of many CCPs involve charging a fixed minimum fee per fund or per account which is relatively high unless the number of OTC derivatives traded and amounts made are very high. This for smaller asset managers could increase costs significantly. Asset managers will have to think of other options to cut these costs, for example by asking institutional clients who have several different funds or accounts to set up an overlay account for the OTC trading. It may be the case that the asset managers will have to look into how their current trading strategies will be affected by the entire EMIR regulation and how they can counteract monetary costs, time costs and performance costs with new and adapted strategies. 

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