EU REGULATIONS – EMIR


EMIR is the European Market Infrastructure Regulation. As this a Regulation and not a Directive then it has direct effect in all EU Member States. It actually applies across the wider European Economic Area (EEA), but in those non-EU Member States – Norway, Lichtenstein and Iceland – EMIR must be transposed into local law.

The purpose of EMIR is to introduce regulations to the Over the Counter (OTC) Derivatives Market, (involving forwards, swaps, options and futures etc.), in order to address the risks that were highlighted during the financial crisis, particularly during the fall of Lehman Bros and others. EMIR focuses on introducing transparency and mitigating counterparty credit risk.

Regulation of the European OTC markets will be completed by a revised Market in Financial Instruments Directive (MiFID II), Market Abuse Directive (MAD II) and Capital Requirements Directive (CRD IV). MiFID will cover exchanges and other trading venues such as Multilateral Trading Facilities (MTF’s), whilst MAD will extend equity markets level surveillance to OTC markets and introduce criminal sanctions for abusive behaviours. CRD IV will impose new capital charges.

As the revised MiFID – which will also take the form of a Regulation (MiFIR) – will require derivatives to be traded over a suitably authorised trading venue, 360T can assure its corporate clients that it will have obtained the appropriate authorisations from its home state regulator, the German Federal Financial Supervisory Authority (BaFin), to ensure that there will be continuity of business.

EMIR is introducing a number of elements:

  • Reporting
  • Clearing
  • Risk Mitigration Requirements
  • Record Keeping

Although EMIR came into force on 16 August 2012, full trade reporting in accordance with the provisions of EMIR did not commence until 12 February 2014.

Is EMIR Applicable to Corporates?
EMIR is applicable to all OTC derivatives markets participants, so yes EMIR will impact corporates should they use the derivatives markets – say to hedge against interest rate or foreign exchange risks, or because they are following an investment strategy. However, the extent to which a corporate will be subject to one or more EMIR requirements will depend on how they are classified.

What do you mean by Classified?
Under EMIR all participants in the derivatives markets will be classified as:

  • A Financial Counterparty (FC)
  • A Non-Financial Counterparty Plus (NFC+)
  • A Non-Financial Counterparty Minus (NFC-)

An NFC is an “Undertaking” established in the EEA which is not an FC. The definition of Undertaking in this sense will include trusts and partnerships as well as Corporate Entities. It will not include individuals.

For a corporate NFC, the difference between being an NFC+ or NFC- will be determined on whether the amount of trading undertaken exceeds the clearing threshold.

What is the Clearing Threshold?
The clearing threshold is a “Sum” set by the European Securities and Markets Authority (ESMA) per financial instrument, and which will serve as the threshold against which NFC’s will have to calculate the rolling average of their outstanding notional positions in derivatives over 30 days. NFC’s exceeding the Sum will be categorised as NFC+’s.

When calculating the average, transactions entered into for hedging purposes can be discarded. However, before we deal with clearing, let’s start by considering reporting.

What is Reporting?
Reporting, which commenced in full on 12 February 2014, applies to all market participants and requires that data in relation to executed derivatives be reported to a Trade Repository (TR), including all those transactions that back date to 16 August 2012. Examples of TR’s are the Depositary Trust and Clearing Corporation (DTCC) and REGIS-TR.

Although regulated platforms such as that provided by 360T are little impacted by EMIR, seeing as the EMIR reporting obligations fall upon the respective counterparties to a trade and not the platform providers, 360T nevertheless plays a vital role in so far as it generates a Unique Trade Identifier (UTI) for all executed transactions.

EMIR requires that the details of any derivative contract concluded, modified or terminated must be reported to a TR no later than the working day following the event in question. This includes all derivatives transactions (spot FX excluded), including inter-group transactions and those transactions entered into solely for hedging purposes. The UTI generated by 360T when used by both counterparties allows for the accurate identification of reported trades and improves the ability to reconcile trades both with and between counterparties, CCPs and TR’s.

NFC’s are also urged to apply for a Legal Entity Identifier (LEI), particularly if they are seeking to delegate reporting to their Financial Counterparty (FC). NFC’s without an LEI may find their FC’s unwilling to report as this could put them in breach of the technical standards set out by the European Securities and Markets Authority (ESMA).

What is Clearing?
Clearing is a process that is presumed to reduce counterparty risk. It does so by replacing trades between counterparties with corresponding trades with a Central Counterparty (CCP). By interposing itself between the participants the CCP becomes the buyer to ever sell trade, and the seller to every buy trade. The London Clearing House or EUREX are examples of CCP’s.

Due to costs and eligibility criteria only FC’s will qualify as Clearing Members. For NFC’s subject to clearing, this means that you will most likely opt for client clearing status – i.e. you will be a client of a Clearing Member FC, or even be a client of a Clearing Member client, a concept known as indirect clearing.

Clearing will only be mandatory for NFC+’s and only in relation to those derivatives declared “Eligible”. It will not be mandatory for NFC-‘s, though market practice may see most derivatives shift to a cleared model.

Eligible OTC derivatives will be those derivatives which the ESMA have determined to be subject to clearing. Although ESMA has yet to inform the market which class of OTC derivatives will subject to clearing, it is clear that interest rate and credit derivatives will be among the first subject to the obligation.

What are Risk Mitigation Requirements?
Risk mitigation requirements apply to all derivatives trades not subject to clearing. The extent to which they will apply will depend on your NFC categorisation, i.e. + 0r -.

Broadly speaking, these requirements mean that NFC’s must have processes in place to monitor and mitigate counterparty risk. Further information on the exact Risk Mitigation Requirements that you are expected to have implemented can be found on the ESMA website: http://www.esma.europa.eu/

Record Keeping
All counterparties to a derivative contract must keep a record of that contract, and of any modifications to that contract, for a period of at least five years following the termination of the contract.

Institutional clients, who will be classified under EMIR as being Financial Counterparties (FC’s), will be subject to all aspects of EMIR. FC’s include: banks, insurers, MiFID investment firms, UCITS funds and their management companies, occupational pension schemes and alternative investment funds managed by a manager under the Alternative Investment Fund Managers Directive (AIFMD).

Those businesses that qualify as Non-Financial Counterparties (NFC’s) under EMIR will be subject to less onerous requirements, and the provisions that apply to them will differ depending on whether they qualify as an NFC+ or an NFC-. It is the responsibility of the NFC to determine exactly which categorisation it falls under, though when dealing with NFC’s, FC’s need to be aware that “know your customer” principles will apply.

The Reporting Obligation
Reporting, which commenced in full on 12 February 2014, applies to all market participants and requires that data in relation to executed derivatives be reported to a Trade Repository (TR), including all those transactions that back date to 16 August 2012. Examples of TR’s are the Depositary Trust and Clearing Corporation (DTCC) and REGIS-TR.

Although regulated platforms such as that provided by 360T are little impacted by EMIR, seeing as the EMIR reporting obligations fall upon the respective counterparties to a trade and not the platform providers, 360T nevertheless plays a vital role in so far as it generates a Unique Trade Identifier (UTI) for all executed transactions. The UTI generated by 360T when used by both counterparties allows for the accurate identification of reported trades and improves the ability to reconcile trades both with and between counterparties, CCPs and TR’s.

For those FC’s that are seeking to undertake trade reporting on behalf of their clients, they are urged to ensure that their clients have obtained a Legal Entity Identifier (LEI).

The Clearing Obligation
The clearing obligation will apply whenever an FC enters into an eligible OTC derivative contract with another FC or an NFC+, subject to EEA establishment rules being satisfied. If one party is exempt from the clearing obligation, then both parties are exempt.

Although it is the responsibility of an NFC to know if it is + or – for clearing purposes, as mentioned above, FC’s should pay particular heed to the “know your customer” principles to which they are subject.

Eligible OTC derivatives will be those derivatives which the European Securities and Markets Authority (ESMA) have determined to be subject to clearing. Although ESMA has yet to fully inform the market which class of OTC derivatives will subject to clearing, it is fairly certain that interest rate and credit derivatives will be among the first to be subject to the obligation. In determining which other derivatives will become subject to clearing in due course, ESMA will consider a derivatives ability to be; standardised, the liquidity of the market and the availability of fair, reliable and generally accepted pricing information. To put it another way, clients should expect the low hanging fruit to be subject to clearing first.

Where clearing is required, then it must be affected through a Central Counterparty (CCP) that has been authorised or recognised by its national regulator to undertake clearing activities. The CCP could also potentially be a non EEA CCP if it has applied for and been granted recognition by ESMA.

Although it is anticipated that clearing will not start until late 2014 at the earliest, it is nevertheless recommended that FC’s should be taking all appropriate steps now to ensure that they are properly prepared.

Risk Mitigation Requirements
These EMIR requirements, which apply to all non-cleared OTC derivative contracts, mean that an FC must have processes:

  • to ensure timely confirmation of transactions, preferably electronic means,
  • to reconcile portfolios – to manage risk, identify and resolve disputes and monitor the value of outstanding contracts,
  • to mark to market on a daily basis the value of outstanding contracts,
  • to have timely, accurate and appropriately segregated exchanges of collateral; and,
  • to hold an appropriate and proportionate amount of capital to manage any risk not covered by collateral exchange.

In addition, FC’s must report to their national regulator on a monthly basis the number of unconfirmed trades that have been outstanding for more than five business days.

FC’s are advised to consult EMSA’s website http://www.esma.europa.eu/ for further information on these requirements and on EMIR more generally.

Record Keeping
All counterparties to a derivative contract must keep a record of that contract, and of any modifications to that contract, for a period of at least five years following the termination of the contract.

EMIR: Trade Reporting Data Provided by 360T
This document has been prepared due to requests from 360T clients for information about trade reporting in accordance with the provisions of the European Market Infrastructure Directive (EMIR).

Regulatory Summary
EMIR entered into force on 16 August 2012. It fulfils several of the European Union’s (EU) G20 commitments to reform the Over the Counter (OTC) derivatives markets: to improve the transparency of the derivatives markets, protect against market abuse and to provide for systemic risk mitigation.

As mandatory reporting of OTC derivatives under EMIR begins to takes effect across the European Economic Area (EEA) – now forecast to commence for all asset classes from 1 January 2014 – all counterparties to OTC derivatives contracts must ensure that they have made appropriate arrangements to report to an appropriately registered Trade Repository (TR). These TR’s will include the likes of REGIS-TR and the DTCC.

Although EMIR had made provision for reporting to be handled by one counterparty, or for reporting to be outsourced to a third party, it appears that whilst European Securities Markets Authority (ESMA) may have been hoping for this outcome, in practice – at least to begin with – many counterparties will have to report directly. This outcome is perhaps attributable to the amount of data fields to be reported, to the disparate sources from where that data may be obtained and because irrespective of who does the reporting, each individual party to the trade will be held responsible for the ultimate accuracy of the data to be reported. Failing to report accurately could expose a counterparty to significant sanctions including both corporate and personal fines, prosecution, reputational damage and ultimately a denial to operate.

How it Impacts You
The details of any derivative contract concluded, modified or terminated must be reported to a TR, and, no later than the working day following the event in question. This includes all derivatives transactions, including inter-group transactions and those transactions entered into solely for hedging purposes.

Exactly what you have to report will depend on the type of counterparty you are, i.e. a Financial Counterparty or Non-Financial Counterparty, the type of transactions you have entered into and, at a later date, whether that transaction will be subject to clearing. It is also important to bear in mind that when reporting starts, you will need to upload all those transactions that have been entered into on or after the 16 August 2012.

Reporting to the Trade Repository
In order to report to a TR all EU counterparties (and certain non EU counterparties) entering into derivative trades will ideally have a Legal Entity Identifier (pre-LEI) in order to meet the EMIR reporting obligations. The issuance of pre-LEIs in line with the agreed principles for pre-Local Operating Unit solutions (LOUs) is currently underway. The announcement of those entities which have been allocated a pre-LOU Prefix for pre-LEI Issuance is posted on the LEI Regulatory Oversight Committee (ROC) website. Please see the LEI ROC website for more information: www.leiroc.org

The data required to be reported under EMIR has been set out in 85 Fields and has been segregated into two categories, (i) the ‘Counterparty Data’ which tends to be more confidential in nature as it will relate to beneficial owner, collateral etc., and (ii) the ‘Common Data’, which is essentially the agreed trade and lifecycle data.

When the counterparties report a trade they will do so referencing a the Unique Trade Identifier (UTI) which has been recognised and adopted as the universal prerequisite for effective trade reporting and aggregation The trade repository[s] will then reconcile the reports and notify counterparties of any discrepancies. The UTI will follow the life cycle of the trade.

Counterparty Data Reporting Fields
To help our clients understand what data fields can be filled from 360T we have provided a colour coded analysis of the 85 fields. In addition to confirming the data available from 360T, this analysis also suggests which fields may be fillable from the Confirmation provider and the fields to the filled by the client.

EMIR Counterparty Data

As there remains uncertainty around the interpretation of some basic concepts with reporting, ESMA intends to issue Q&As on a periodic basis. We therefore advise clients who are potentially impacted by EMIR to monitor developments on an on-going basis by checking for updates on the ESMA website: www.esma.europa.eu.

Clients are also welcome to contact 360T Regulatory at regulation@360t.com.