Canadian firms (among others) will continue to be asked by European counterparties in the global over-the-counter derivatives market to provide information to enable the aforementioned counterparties to comply with the European Market Infrastructure Regulation (EMIR) under Regulation (EU) No. 648/2012 of the European Parliament.
By April 30, 2014, any entity under the jurisdiction of the British regulator Financial Conduct Authority (FCA) is required to implement risk mitigation measures relating to OTC derivatives and other instruments covered by EMIR.
BACKGROUND
A wide range of compliance obligations affecting parties trading OTC derivatives with European counterparties went into effect this year, including, for example, OTC reporting requirements that came into force on February 12, 2014. Risk mitigation requirements in Europe first went into effect on September 13, 2013 and a leading regulator in Europe, the U.K. Financial Conduct Authority (FCA), issued in March 2014 an advisory that it expects EMIR risk mitigation measures to be in place by no later than April 30, 2014. The FCA publicly stated that firms that had not already implemented the risk mitigation requirements of EMIR should prepare a "detailed and realistic" compliance plan "within the shortest time-frame possible" and that "The FCA expects that such plans will be completed and implemented by 30 April 2014 and that firms will be able to demonstrate compliance after that date".
RISK MITIGATION GENERALLY
European and U.S. derivatives laws currently require parties on both sides of an OTC derivative trade to implement internal processes and procedures that are designed to mitigate the risk of default. Eventually many or all regulators of derivatives will require these or similar measures. Regulators in the leading markets were concerned in 2008-09 that the risk of default of market participants threatened the health of the financial markets as a whole. As a result, regulators have more recently imposed new requirements that apply either directly or indirectly depending upon the jurisdiction in which an entity is organized and operates (and the counterparties with whom it trades OTC derivatives).
APPLICATION TO ENTITIES OUTSIDE OF THE EU
The European Securities and Markets Authority (ESMA) clarified in published guidance that EMIR Risk Mitigation applies to non-EU entities classified as third country entities. It stated, "Article 11 of EMIR, which provides the basis of these [Risk Mitigation] requirements, applies wherever at least
one counterparty is established within the EU. Therefore where an EU counterparty is transacting with a third country entity, the EU counterparty would be required to ensure that the requirements for portfolio reconciliation, dispute resolution, timely confirmation and portfolio compression are met for the relevant portfolio and/or transactions even though the third country entity would not itself be subject to EMIR. However, if the third country entity is established in a jurisdiction for which the Commission has adopted an implementing act under Article 13 of EMIR, the counterparties could comply with equivalent rules in the third country."
PORTFOLIO RECONCILIATION
Portfolio reconciliation is a post execution process that involves sending or receiving data from each counterparty and conferring by phone, email or otherwise to ensure that both sides to a derivative are in agreement on trade details, events that take place during the pendency of a trade and valuation and collateral issues. If EMIR portfolio reconciliation obligations apply, your firm has to select one of two options and adopt that option in internal policies and procedures:
Option A: Bilateral reconciliation (your firm and its counterparty exchange portfolio data)
Option B: Unilateral reconciliation (only your firm's counterparty sends its portfolio data to you)
Many European counterparties have developed a dedicated web portal for unilateral reconciliation ("one-way delivery of portfolio data") because many of their counterparties have selected Option B. In this case, the European counterparty will send a designated person an email two weeks prior to the reconciliation date informing that person that the portfolio will be made accessible on a web portal on the date of the reconciliation. You will then be asked to approve the data or inform the counterparty of any issues with respect to the data (differences in internal valuations and so forth).
The key point is that your operations and legal teams will have, following the date on which data is made accessible, generally only five (5) business days (that are business days for both parties to the derivative), or a shorter period, if agreed, to object to the data. If no objection is made, then the data provided by the counterparty will be deemed the "correct" data and no objections can be made.
DISPUTE RESOLUTION
EMIR also requires that European counterparties (and their counterparties) implement a dispute resolution process. The reason that regulators require these processes is that, in the past, disputes have resulted in massive losses that have destabilized the system, and regulators were not aware of those losses until massive damage was done to the system. Today, regulators are requiring parties to implement internal policies and procedures to meet and confer and to identify and resolve disputes. If those disputes exceed a threshold in the aggregate, then the parties are to report those disputes to the applicable regulator. Such dispute resolution process should apply to transactions and collateral margin calls.
PORTFOLIO COMPRESSION
In addition to the above obligations, counterparties are required to assess the possibility of a portfolio compression with certain counterparties. If these obligations apply, it is recommended that your firm have internal tracking processes in place to ensure that a compliance professional is contacted if this threshold is exceeded.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.