EU Regulation 648/2012 or the "European Market Infrastructure Regulation" (EMIR) has been in force for over a year but its implications had been unclear pending the publication of the corresponding regulatory and implementing technical standards. Now that a number of the technical standards are in place, it is timely to consider the principal implications of EMIR for Irish regulated funds (Funds) such as UCITS and alternative investment funds authorised by the Central Bank of Ireland (CBI).

What is EMIR?

EMIR is the EU Regulation on OTC derivatives, central counterparties and trade repositories. Amongst other things, it imposes: (a) mandatory central counterparty clearing of certain standardised OTC derivative contracts (central clearing); (b) risk mitigation requirements in relation to transactions which are not centrally cleared; and (c) general reporting obligations.

EMIR distinguishes between: (a) financial counterparties (FCs); (b) non-financial counterparties whose volume of derivatives activity at group level does not exceed a certain threshold (NFC-s); and (c) non-financial counterparties whose volume of derivatives activity at group level does exceed those thresholds (NFC+s). FCs are subject to the most onerous range of obligations under EMIR.

Are Funds subject to EMIR?

Yes. UCITS authorised in accordance with the UCITS Directive (Directive 2009/65/ EC) and alternative investment funds managed by an alternative investment fund manager authorised or registered in accordance with the Alternative Investment Fund Managers Directive (Directive 2011/61/EU) are classified as FCs for the purposes of EMIR and are therefore subject to the full range of obligations. The EMIR requirements will apply regardless of whether a Fund enters into derivatives contracts directly or through an agent (such as an investment manager).

Will a Fund's derivative transactions be subject to central clearing?

EMIR requires mandatory central counterparty clearing of certain standardised OTC derivatives contracts. As an FC, a Fund will be required to centrally clear those OTC derivatives contracts which are subject to the clearing requirement.

The European Securities and Markets Authority (ESMA) is currently in consultation with industry to determine the classes of OTC derivatives which should be subject to the mandatory clearing obligation. It is likely that the clearing obligation will apply in respect of the more liquid standardised producttypes such as interest rate, currency and credit derivatives. The consultation closes on 12 September 2013 after which time the relevant technical standards will be published by EMSA and submitted to the European Commission for endorsement in the form of a Commission Regulation.

Funds will need to negotiate documentation at the appropriate time to allow derivatives transactions entered into after the relevant clearing obligation date to be cleared through a central clearing counterparty.

Reporting requirements

EMIR requires that each party to a derivatives contract report prescribed details of the transaction to a trade repository. A Fund will be permitted to delegate its reporting obligation to its counterparty or a third party but will remain primarily responsible for compliance.

The deadline for reporting depends on the nature of the derivative contract (whether credit, equity, interest rate, foreign exchange or other) and when the derivative contract is/was entered into. Note that the reporting obligation applies to legacy transactions – i.e. those derivative contracts which were entered into (a) before 16 August 2012 (the date EMIR came into force) and remained outstanding as at that date or (b) after 16 August 2012.

The reporting obligation is not yet in force. It is expected to come into force in Q1 2014, subject to recognition of relevant trade repositories, and will be phased in according to different asset classes.

Timely confirmation

As of 15 March 2013, counterparties (including FCs) were required to have in place procedures and systems to ensure that transactions are confirmed as between the parties within the deadline set out in the applicable technical standards.

Funds should ensure that their operational procedures are consistent with the EMIR requirements.

Portfolio reconciliation

The portfolio reconciliation requirements come into effect on 15 September 2013. These will require Funds to have arrangements in place with their counterparties which allow details of outstanding derivatives transactions to be verified before entering into a derivative contract.

The reconciliation may be performed either by the counterparties themselves or by delegated third parties on their behalf.

The frequency with which a Fund will be required to the carry out the reconciliation procedure will depend on the number of open transactions it has in place with a particular counterparty.

Dispute resolution procedures

As of 15 September 2013, Funds will also be required to have agreed detailed processes and procedures in place with their derivatives counterparties in relation to the identification, recording, monitoring and resolution of disputes regarding to their derivative contracts and to the exchange of collateral.

The procedures will need to provide for the resolution of disputes in a timely manner with specific processes for those disputes that are not resolved within 5 business days.

Portfolio compression

Funds with 500 or more outstanding derivatives contracts with a particular counterparty must have procedures in place so that they can determine regularly (and at least twice a year) whether to conduct a portfolio compression exercise in order to reduce their counterparty credit risk. If they do not conduct a portfolio compression exercise, they must be able to provide a reasonable and valid explanation to the competent authority (which, in Ireland, is expected to be the CBI).

The portfolio compression requirements come into effect on 15 September 2013.

Daily valuations

Since 15 March 2013, FCs have been required to mark-to-market on a daily basis the value of their outstanding derivative contracts. In circumstances where marking-to-market is not appropriate, a mark-to model valuation may be performed.

Many Funds will already have in place procedures to facilitate daily valuations. However, it would be important to ensure that these procedures meet the requirements of EMIR, particularly if such procedures pre-date the coming into effect of EMIR.

Margin requirements

Since 15 March 2013, Funds have been required to have in place risk management procedures that require the timely, accurate and appropriately segregated exchange of collateral in respect of uncleared derivatives contracts. FCs will be subject to increased capital requirements if such collateral is not exchanged.

The collateral requirements in respect of uncleared OTC derivatives are expected to be amplified in technical standards to be produced by ESMA. Once those technical standards are in force (not expected until 2014 at the earliest), the collateral exchange procedures of FCs (and NFC+s) will be required to comply with those standards.

What next?

In the immediate term, Funds should focus on implementing the changes necessary to comply with the portfolio reconciliation and dispute resolution requirements which come into effect on 15 September 2013.

In order to do so, Funds can opt either to bilaterally amend their OTC derivatives documentation or to adhere to the ISDA 2013 EMIR Portfolio Reconciliation, Dispute Resolution and Disclosure Protocol. It will be necessary to engage with counterparties to determine the most appropriate course of action.

Funds should also conduct an analysis to ensure that their existing procedures and documentation comply with those requirements of EMIR which are already in force.

Longer term, the themes of central clearing and exchange of collateral are likely to dominate.

This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.