UK: Clearing Obligations And Margining Of Uncleared Swaps Under EMIR – Time To Determine Your Status

Last Updated: 22 April 2016
Article by Guy Usher, Edward Miller, Luke Whitmore and Azad Ali

In Europe, we now have what are expected to be the final rules for the margining of uncleared swaps under EMIR as well as the rules for the mandatory clearing of certain OTC derivatives. These are each contained in separate Regulatory Technical Standards or RTS.

The earliest clearing obligation applicable to certain types of interest rate derivatives applies from 21 June 2016. This only affects what is known as Category 1 firms – i.e. those which are clearing members of the CCPs which clear those products. The clearing obligation for these products is extended to apply to Category 2 firms from 21 December 2016.  Category 2 firms include (a) all financial counterparties (FCs) and (b) alternative investment funds which are non-financial counterparties whose OTC derivatives are over the EMIR clearing threshold (so-called NFC+s), in each case with uncleared OTC derivatives in excess of EUR 8 billion.  Other FCs and other NFC+ alternative investment funds will be Category 3, whose obligation to clear arises later.  As a consequence, at the latest from 21 December 2016 (and possibly by as early as 21 June 2016) all FCs and NFC+s which are alternative investment funds (and non-EU equivalents trading with EU counterparties) will need to declare their status in order to trade these products in the market, NFC+s which are not alternative investment funds are Category 4 and are not subject to any volume-based threshold with respect to their clearing obligations which arises later still.

Similarly, the final uncleared swaps margin rules only start to apply from 1 September 2016.  As a result, from that date all FCs and NFC+s (and non-EU equivalents trading with EU counterparties) will need to declare their status in order to trade any OTC derivatives, as the requirements to post initial margin are dependent on the notional amount of uncleared OTC derivatives. The compliance start dates for the margining of uncleared swaps are as indicated on these timelines.

The assessment periods for determining the dates for compliance with both sets of rules have already begun.  All FCs and NFC+s (and those who would be FCs and NFC+s if established in the EU) need to make a self-assessment of their trading volumes for one or both sets of rules.

Whether an FC or NFC+ is above or below the relevant threshold for the September 2016 implementation date for the exchange of initial margin for uncleared swaps is to be determined based upon the aggregate average month end notional amounts for uncleared OTC derivatives for March, April and May 2016.  This level is referred to as an entity's "AANA", short for "average aggregate notional amount", and is required to be calculated on a group basis.

Whether an FC or NFC+ which is an alternative investment fund (and non-EU equivalents trading with EU counterparties) is a Category 2 or, a Category 3 entity for the purposes of the earliest EU clearing obligation is to be determined based upon that entity's AANA for January, February and March 2016.

NFCs have for some time had to make a similar determination in order to establish whether they are NFC+ or NFC- for the purposes of their obligations under EMIR.  Whilst the AANA assessment now required is different (it is not a continuous assessment; there is no carve out for hedging transactions; and it is only uncleared OTC derivatives which are included), some of the issues which faced NFCs are also relevant to the determinations which FCs and NFC+s now have to make.

In the same way as NFCs were previously required to represent their status (as an NFC+ or NFC-), FCs and NFC+s are now going to have to start to declare their AANA status from the relevant start dates, even if they are very light users of OTC derivatives.  In order to carry out an assessment, every FC or NFC+ which may enter into an OTC derivative will need to consider the following questions:

What is an "OTC derivative"?

For the purposes of EMIR, an "OTC derivative" is any instrument which is a derivative under MiFID and which is not traded on a regulated market (as defined in MiFID) or on a third country market considered equivalent to a regulated market in accordance with the new Article 2a of EMIR (as inserted by the Securities Financing Transactions Regulation). 

As of today there are no non-EU equivalent markets for this purpose so that all derivatives traded on a non-EU exchange are currently treated as OTC derivatives for the purposes of EMIR.  Equivalence decisions are expected soon, so that what is included as an OTC derivative will have to be revisited.

At the boundaries, there are slightly different definitions of what constitutes a "derivative" across EU Member States given that MiFID was implemented locally by individual EU Member States, resulting in variances across the EU in what is considered a "derivative".  We saw this issue with FX transactions when trade reporting under EMIR was introduced.

Whilst a harmonious definition of what constitutes an OTC derivative should be in place when MiFID2/MiFIR is finally implemented, as of today there is still significant regional variance within the EU.

Although the impact of these different interpretations across the EU has significantly lessened with the delayed phasing in of the margining requirements for uncleared FX transactions, the issue is still "live" as regards the AANA calculation, in which FX forwards have to be incuded.

What is an "uncleared" OTC derivative?

This distinction does not arise in the context of an NFC+ versus NFC- assessment as that includes all OTC derivatives (cleared and uncleared).  However, it does arise in the context of the AANA assessment.

In terms of what "uncleared"  derivatives are, the question arises as to whether this refers to derivatives "not cleared anywhere at all" or "not cleared by an authorised EU CCP or a recognised third country CCP".  The rules are not clear on this point and it may be that this issue will only be clarified by a future ESMA Q&A.  We would suggest that the second of the two interpretations is more likely to be the one which ESMA will adopt (and is the more conservative) but the rules can quite easily be interpreted to mean "not cleared anywhere", whether in the EU or not.

The lack of clarity on this issue is significant and, for the moment, it is recommended that parallel calculations are conducted.

What constitutes a "group"?

The AANA has to be calculated on a group basis, which begs the question as to what is meant by "group" for these purposes.  When NFCs were making their status assessment, there was some uncertainty (given the definition of "group" in EMIR) as to whether "group" meant only the EU group or the world-wide group.  In its earlier Q&A on the NFC+/- assessment, ESMA clarified that group meant the world-wide group wherever the ultimate parent is located.

Separate funds of a manager or sub-funds of an umbrella fund will not form a group for EMIR purposes provided they are bankruptcy remote from each other.

How are intra-group transactions counted?

As with the NFC +/-  status assessment, intra-group trades are to be included in the relevant calculation.  The final rules for margining of uncleared swaps clarified that, for AANA calculation purposes, only one leg/side of an intra-group transaction should be included.  Although this is consistent with the US standard, it contrasts with the NFC +/-  status assessment, where both legs of a non-exempt intra-group transaction are counted.

The rules which mandate the earliest clearing of interest rate swaps are silent on this issue but the same position as under the final rules for the margining of uncleared swaps can be assumed to apply also to the clearing obligation calculation.

What is meant by "notional amount"?

Certain types of derivative, including options and commodity derivatives, do not have notional amounts. Other derivatives have variable notional amounts. In its earlier Q&A on the NFC+/- assessment, ESMA gave guidance on how to make the calculation in these situations, which would be equally applicable to the AANA calculation.

Audit

It is important that any EU entity which transacts uncleared OTC derivatives is able to demonstrate to its national competent authority (such as the FCA in the UK) that it understands the calculations that it is required to make in order to determine the extent of its obligations under EMIR.

In practice this will mean having documented procedures in place, appointing a person responsible for ensuring that the calculations are made and maintaining records of the calculations and data used.

Other regimes

Whilst there has been a great deal of global convergence in terms of regulatory implementation of the BCBS-IOSCO framework for margin requirements for non-centrally cleared derivatives (March 2015), inevitably there are differences between the AANA assessments which have to be made under different regulatory regimes.  It is possible that entities will need to be able to determine their AANA under multiple regimes in order to maintain existing trading relationships.

This sister publication describes the equivalent requirements under the US regimes.

Publication of status

ISDA has published an EMIR Classification Letter for the purposes of certifying status for the purposes of the EMIR clearing obligations. This will be required by 21 December 2016 and certain counterparties may insist on it following the July 2016 start date, even though there is no volume based threshold at that time.

ISDA will also shortly be publishing a form of self–disclosure letter which will facilitate the publication of counterparty status for the purposes of margining of uncleared swaps.  However, as it stands, this does not provide advice or guidance on how to carry out the calculations.  It is merely a communication portal.

Annual assessment

The initial AANA assessment period will determine whether or not September 2016 compliance is required under the final rules for the margining of uncleared swaps.  Going forward, in the EU, an annual assessment of the AANA needs to be made for these purposes based upon the average of the March, April and May aggregate month end notional amounts and any change in status will be effective from the following January.

For the purposes of the clearing obligation implementation dates a one-off determination of AANA only is needed for each class of OTC derivatives which is subject to mandatory clearing (as there will be a separate RTS for each class of OTC derivative for which the clearing obligation is introduced).

Asset manager issues

As usual, asset managers have additional issues to consider.

For managed account clients, the manager will likely not have visibility to all the client's positions and the client may not understand the calculations which the manager is asking it to confirm, especially across various different regimes which are based upon the location of the counterparty that the manager has decided to trade with.

The clients could be potentially subject to AANA calculations under a whole range of different regimes, not all of which may even be familiar to the manager. Even with its own EU fund range, it may manage funds which are subject to a different definition of OTC derivative under MiFID with respect to FX forwards.

And lastly there is the issue of how to make available each client's status to the market and who has responsibility for that.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Luke Whitmore
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions