European Union: Council Of EU Adopts The EMIR Refit Regulation

On 14 May, 2019, the Council of the European Union issued a press release1 announcing that it had adopted at first reading the proposed Regulation to amend EMIR (the Regulation on OTC derivative transactions, central counterparties (CCPs) and trade repositories (648/2012)) (the "EMIR Refit Regulation")(2017/0090(COD)). The press release indicates that the EMIR Refit Regulation will be signed in the week of 20 May 2019 and will enter into force 20 days following its publication in the Official Journal.

For the purpose of this client briefing, we focus on the key changes introduced by the new EMIR Refit Regulation for the clearing obligations for AIFs and UCITS. We also highlight certain actions which such entities need to take on the day.

Overview

The European Commission proposed substantial changes to Regulation (EU) No 648/2012 ("EMIR") in May 2017 with respect to the clearing and reporting obligations incumbent on counterparties in derivatives. These became known as the "EMIR Refit" proposals on the basis that the review of EMIR took place as part of the Commission's Regulatory Fitness and Performance (REFIT) programme.

Following a series of negotiations on the Refit text proposal, the Romanian presidency of the Council and the European Parliament reached a preliminary agreement on 5 February, 2019. The European Parliament adopted the legislation at first reading on 18 April 2019.

The EMIR Refit Regulation will enter into force 20 days after it is published in the Official Journal of the EU. Except for certain limited exceptions, it will apply from the date of its entry into force.

The EMIR Refit Regulation aims to simplify the rules for OTC derivatives and make them more proportionate, with a view to reducing regulatory costs and burdens on market participants.

"Financial counterparty" ("FC")

The EMIR Refit Regulation will broaden the definition of "financial counterparty" ("FC") to capture all AIFs which are established in the EU, as well as AIFs which are managed by AIFMs authorised or registered in accordance with Directive 2011/61/EU ("AIFMD").

This is a change to the position currently under EMIR, as EMIR only captures AIFs which are managed by AIFMs authorised or registered in accordance with AIFMD as FCs. UCITS and UCITS management companies remain captured as FCs under both EMIR and the EMIR Refit.

AIFs which are securitisation special purpose entities, and AIFs/ UCITS which are established solely for employee share purchase plans, will be specifically excluded from the definition of an FC under the EMIR Refit Regulation.

"Small financial counterparty" ("SFC")

The EMIR Refit Regulation introduces a new sub-category of FC which will be exempt from the EMIR clearing obligations. This new sub-category is termed a "small financial counterparty" ("SFC"). An FC will be deemed to be an SFC if its OTC derivative positions do not exceed any of the EMIR clearing thresholds.

Whilst an FC which is categorised as an SFC will be exempt from the EMIR clearing obligations, it will remain subject to EMIR's risk mitigation requirements, including margin exchange requirements.

Determination of clearing threshold - FCs

The EMIR Refit Regulation provides that an FC has the option to perform a calculation every 12 months to determine whether its aggregate month-end average position at group level (for the previous 12 months) exceeds the clearing thresholds. If the calculation is performed and none of the clearing thresholds are exceeded, the FC will be deemed to be an SFC and will be exempt from the EMIR clearing obligations.

An FC that exceeds the clearing threshold for at least one asset class or does not calculate its positions, will become subject to a clearing obligation for all asset classes.

Whilst the calculations are normally performed at group level, the EMIR Refit specifically provides that for UCITS and AIFs, these calculations are performed at the fund level. Where the UCITS management company manages more than one UCITS, or where the AIFM manages more than one AIF, they must be able to show that the calculation at fund level does not lead to a systematic underestimation of the positions of the funds that they manage (or the positions of the manager) nor the clearing obligations being circumvented.

Unlike the position for NFCs, the calculation of clearing thresholds for FCs must include all OTC derivative contracts (i.e. whether for hedging purposes or not).

Determination of clearing threshold - non-financial counterparties ("NFCs")

Under EMIR, the determination of whether an entity is NFC+ or an NFC- is made using the same clearing thresholds that apply to determine whether an FC is an SFC. The EMIR Refit Regulation replaces the 30 day rolling average determination of positions, as set out under EMIR, with an annual determination on the same basis as explained above for SFCs.

The EMIR Refit Regulation provides that an FC has the option to perform a calculation every 12 months to determine whether its aggregate month-end average position at group level (for the previous 12 months) exceeds the clearing thresholds. If the calculation is performed and none of the clearing thresholds are exceeded, the NFC will be deemed to be an NFC- and will be exempt from the EMIR clearing obligations.

In addition, under the EMIR Refit Regulation, an NFC will only be required to clear those OTC derivative contracts which relate to the particular asset class for which the clearing threshold is exceeded. This is a change from the position currently under EMIR whereby once an NFC's position in OTC derivatives exceed any of the clearing thresholds, it must clear all OTC derivatives of all classes which are subject to the mandatory clearing obligation.

The EMIR Refit Regulation retains the current position that an NFC may exclude hedging contracts when calculating whether or not it has exceeded the clearing thresholds.

An NFC that does not calculate its positions, will become subject to a clearing obligation for all asset classes. An NFC that exceeds the clearing threshold for at least one asset class, will become subject to a clearing obligation for that particular asset class.

Notifications to Central Bank and ESMA

All FCs or NFCs which do not calculate their aggregate month-end average position for the previous 12 months, or where the result of that calculation exceeds any of the clearing thresholds, whether previously subject to the clearing obligation or not, are required to immediately notify ESMA and their relevant competent authority. Such an entity has four months from making that notification to implement the clearing arrangements, as applicable.

Removal of the frontloading requirements

The EMIR Refit Regulation removes the clearing frontloading obligation. The frontloading obligation is the obligation to clear OTC derivative contracts entered into, or novated, before the clearing obligation for those classes of derivatives takes effect.

Actions to be taken on the day the Refit text enters into force

In a public statement issued by ESMA entitled "Implementation of the new EMIR Refit Regime for the clearing obligation for financial and non-financial counterparties" (28 March 2019) (the "Public Statement"), ESMA provides guidance on the timings as to; (a) when FCs and NFCs need to initially perform the clearing threshold calculations provided for under the EMIR Refit; and (b) when FCs and NFCs initially need to notify ESMA and their relevant competent authority that they are indeed subject to the clearing obligation.

The Public Statement highlights that the published Refit text does not include a delayed implementation of this new regime. As a result, ESMA clarifies that FCs and NFCs choosing to conduct the calculation need to be in a position to perform the clearing threshold calculations provided for under the EMIR Refit on the day the Refit text enters into force.

The Public Statement also clarifies that all FCs or NFCs which do not calculate their aggregate month-end average position for the previous 12 months, or where the result of that calculation exceeds any of the clearing thresholds, whether previously subject to the clearing obligation or not,are required to immediately notify ESMA and their relevant competent authority on the same day the Refit text enters into force.

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.

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