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  • EMIR - Mandatory clearing, risk control measurement and transaction reporting for OTC derivatives

    As a consequence of the European Market Infrastructure Regulation (EMIR), additional rules will apply to companies that enter into OTC derivatives. As a result, the costs and the administrative burden for OTC derivatives will increase.


    The new rules for OTC derivatives involve:

    1. a clearing obligation for certain categories of OTC derivatives,
    2. the introduction of risk management measures for OTC derivatives which are not subject to the clearing obligation, and
    3. a reporting obligation for all OTC derivative contracts.

    For which parties do the EMIR obligations apply?

    Whether the obligations under EMIR will apply to a party of a derivative contract depends on the classification of the party as a financial counterparty or a non-financial counterparty.

    Non-financial counterparties
    Non-financial counterparties are all companies resident in the EU, with the exception of central counterparties (legal entities which conclude derivative contracts) and financial counterparties.

    Financial counterparties
    Financial counterparties are all entities which hold a licence as an investment company, credit institution, insurer, pension fund, undertaking for collective investment in transferable securities (UCITS) and an alternative investment fund (AIF) which is managed by an AIF-manager.

    In case a financial counterparty concludes an OTC derivative with a non-financial counterparty, the financial counterparty is required to execute the rules of EMIR also on behalf of the non-financial counterparty. The financial counterpart can transfer the related costs to the non-financial counterparty.

    To which OTC derivatives do the EMIR obligations apply?

    The concept “OTC derivatives” includes the following types of contracts:

    1. options, futures, swaps, forward rate agreements and other derivative contracts relating to:
      1. securities, currencies, interest rates, indexes or standards, climate variables, transport prices, issue licences, inflation rates or other economic statistics, assets, rights, obligations or indices.
      2. commodities which have to be settled in cash, or may be settled in cash, or can be settled via physical delivery and that are traded on an exchange;
    2. derivative contracts for the transfer of credit risks; and
    3. contracts for differences;

    provided that these are not traded on a regulated market but are concluded on a bilateral basis or via a multilateral trading facility or other trading platform which is not a regulated market.

    Clearing obligation

    Financial counterparties have an obligation to clear OTC derivatives.

    Non-financial counterparties have a clearing obligation if they enter into OTC derivatives for speculative purposes and the total nominal value exceeds a certain threshold. The clearing obligation only applies where a non-financial counterparty, which exceeds the clearing threshold, enters into an OTC derivative with: (a) another non-financial counterparty which exceeds the clearing threshold; or (b) a financial counterparty.

    Speculative purposes

    Non-financial counterparties do not fall within the clearing obligation if they only enter into OTC derivatives which can objectively be established to reduce the risk directly related to the commercial activities or treasury finance activities of the non-financial counterparty or its group. OTC derivatives fall within this non-speculative category if the OTC derivative (either alone or in combination with other derivatives):

    1. hedges a potential risk of changes in the value of goods, services, products/commodities or obligations which the non-financial counterparty or the group owns, produces, processes or buys/sells, or it is reasonably expected that it will do so; or
    2. hedges a potential risk of changes in the value of the above assets and obligations which are directly or indirectly the consequence of interest fluctuations, inflation or changing exchange rates; or
    3. qualifies as a hedge under the IFRS rules.

    Exceeding the threshold

    If non-financial counterparties also enter into OTC derivatives for speculative purposes, they have to calculate whether the total nominal value (notional value) of the OTC derivatives they have entered into (i.e. both speculative and non-speculative) exceeds the thresholds laid down in the Implementing Regulations. The thresholds currently proposed for consultation are as follows:

    1. EUR 1 billion nominal value for credit derivatives and share derivatives;
    2. EUR 3 billion nominal value for interest percentage derivatives and currency exchange rate derivatives: and
    3. EUR 3 billion nominal value for commodity derivatives and other OTC derivatives not specifically mentioned under (a) – (c).

    In calculating whether its positions exceed the thresholds, a non-financial party is required to:

    1. refer to the average on-going position over a period of 30 working days;
    2. take into account all OTC derivatives entered into by itself or any of its group companies;
    3. not include OTC derivatives which can objectively be established to relate directly to commercial activities or financial treasury activities; and
    4. determine the total nominal value of the OTC derivatives entered into per type of derivative.

    If the non-financial counterparty falls within the clearing obligation on the basis of this calculation, it must notify ESMA and the competent supervisor. All OTC derivatives entered into after the clearing threshold has been exceeded will have to be cleared by a central counterparty (to the extent that they have been designated for mandatory clearing by ESMA).

    Intra-group exemption

    A non-financial counterparty can benefit from the intra-group exemption if it enters into a transaction with another counterparty which is resident in the EU, or in a third country in relation to which the Commission has determined that adequate supervision is exercised there, and:

    1. the counterparty is part of the same group;
    2. both counterparties are included in the same full consolidation; and
    3. both counterparties are subject to procedures for the central evaluation, ascertainment and auditing of risks.

    Entities in non-EU Member States

    Entities from non-EU Member States can also be subject to the clearing obligation. The following situations can be derived from EMIR in which such counterparties will be required to meet the clearing obligation:

    1. a non-financial counterparty (above the clearing thresholds) or a financial counterparty from an EU Member State enters into a derivative with an entity from a non-EU Member State which would be subject to the clearing obligation if it was resident in an EU Member State; or
    2. two entities which are resident in one or more EU Member States which would be subject to the clearing obligation if they were resident in EU Member States, if:
      1. the OTC derivative has significant and foreseeable direct consequences within the EU, or
      2. if an obligation to that effect is appropriate or necessary to prevent the provisions of EMIR from being circumvented.

    Risk mitigation techniques for un-cleared OTC derivatives

    For all OTC derivatives entered into by a non-financial counterparty which are not cleared by a central counterparty, certain risk mitigation techniques have to be implemented. Appropriate measures and procedures must be in place to measure, monitor and mitigate the operational risk and counterparty credit risk. EMIR therefore requires action to be taken on this point for all non-financial counterparties which enter into OTC derivatives and which have not already taken the measures mentioned above. The risk mitigation techniques will be further elaborated in the Implementing Regulations for which ESMA and the ESAs have already produced proposals. The following measures must be considered in relation to the risk mitigation techniques:

    1. The use of electronic means of ensuring timely confirmation of the conditions of the OTC derivative contract. Under ESMA’s proposals non-financial counterparties must, to the extent that they exceed the clearing threshold, confirm OTC derivative contracts as quickly as possible, but in any event before the end of the day on which the contract is concluded. Non-financial counterparties which do not exceed the clearing threshold must confirm OTC derivative contracts as soon as possible, but in any event within two working days after the date on which the contract was concluded.
    2. The availability of processes to reconcile portfolios, manage associated risks, identify and resolve disputes between parties in good time, and to monitor the value of outstanding contracts. On the basis of ESMA’s proposals, the frequency of the portfolio reconciliation will be determined by the size of the portfolio between two counterparties.
    3. The parties must value the outstanding contracts at fair (market) value on a daily basis. If market conditions make this impossible, the parties must establish the value on the basis of reliable and precise marking-to-market models.
    4. Collateral obligations: non-financial counterparties must have risk mitigation procedures requiring a timely, accurate and appropriate separate exchange of collateral. However, this only applies as soon as they exceed the clearing threshold discussed above.

    Intra-group exemptions

    OTC derivatives entered into between group companies which meet certain conditions (including unrestricted transfers of assets between the parties) are excluded from the obligation to take risk mitigation measures under (4 – Collateral Obligations). For group companies that enter into OTC derivatives with each other it is therefore important to see whether one of these exemptions applies.

    Entities in non-EU Member States

    If derivative contracts are concluded between entities from one or more non-EU Member States which have a significant impact in the EU, the rules concerning risk mitigation techniques and the exemptions from these rules for intra-group transactions apply accordingly.

    Reporting and data retention obligation

    Finally, EMIR introduces a reporting and data retention obligation. The reporting obligation applies to all derivative contracts and all counterparties. The reporting obligation can be delegated to a third party. The reporting obligation means that counterparties have to report information relating to all derivative contracts concluded (and any change or termination of such contracts) by them to a trade repository. The minimum information which the parties have to report to a trade repository pursuant to this obligation consists of:

    1. the parties to the contract and the beneficiaries of the rights and obligations arising under the contract; and
    2. the main characteristics of the derivative contract, including the type, underlying redemption date, nominal value, price and settlement date.

    ESMA has proposed that the information to be reported should be split into two parts. First, the part with the counterparty information – this part has to be separately reported by each counterparty (or a third party to which the counterparty has delegated this activity). Second, a part containing collective information – this part can be reported by only one counterparty (if the name of the other counterparty is also stated) or a third party to which the notification of information to the trade repository has been delegated (the ‘third party reporting entity’).

    In the proposed Implementing Regulations ESMA has also included a table of points which must form part of a transaction report. The table categorises the information in accordance with the above breakdown between counterparty information and collective information. It also indicates what additional information is required for special types of derivatives (e.g. for commodity derivatives the transaction report must also state the name of the commodity group).

    The report must be made not later than one working day after the contract is entered into, amended or terminated. EMIR provides that the parties will not be in breach of any contractual (or statutory) duties of confidentiality if they comply with the reporting obligation.

    The reporting obligation will apply to derivative contracts which:

    1. were concluded before 16 August 2012 (the date on which EMIR came into force) and are still in force on that date;
    2. are concluded on or after 16 August 2012.

    A transitional rule applies to the extent that the rules relating to the reporting obligation are still to be developed in the Implementing Regulations. The rules that are included in the Implementing Regulations will come into force on a date to be specified by ESMA in the Implementing Regulations.

    Apart from that, counterparties are also required to retain information relating to all derivative contracts concluded by them, and any changes to such contracts, for five years following the termination of the derivative contract.


  • Posted on May 20, 2015