Summary and implications

We have been talking about the European Market Infrastructure Regulation (EMIR) for years. With certain parts of EMIR now in force and others planned imminently, here are 10 key questions to help you understand if, and how, you will be affected by EMIR.

1. Should I care about EMIR?

Generally, if you are based in the European Economic Area and trade in derivatives, whether on-exchange or "over-the-counter" (OTC), then you will be impacted by EMIR. This could include real estate investors who use derivatives and swaps (e.g. hedging interest rate and currency risks) to reduce risk rather than for speculative purposes. The exact impact of EMIR will depend on the type of firm, as well as the level and type of derivative exposure of the particular firm.

2. What are the requirements under EMIR?

In summary, EMIR brings in new requirements relating to:

  • authorisation and supervision of central counterparties (CCPs) and trade repositories (TRs);
  • reporting trade details of all derivative trades (not just OTC) to TRs;
  • clearing "eligible" OTC derivatives through a CCP; and
  • when OTC derivatives are not centrally cleared, firms will need to implement alternative risk mitigation techniques.

While only a handful of firms are expected to become CCPs or TRs, other firms will need to consider how to comply with the requirements relating to clearing and trade reporting.

3. How do I satisfy the reporting requirement?

EMIR requires certain details of all derivatives (both OTC and on-exchange) to be reported to a TR by both counterparties.

From a practical perspective, once a TR has been registered to receive reporting information in relation to the type of derivative concerned, a firm must either:

1. enter into direct arrangements with a TR; or

2. delegate reporting arrangements to a third party (such as a broker, CCP or trading platform), which would in turn have an arrangement with a TR.

4. How will clearing work?

The European Securities and Markets Authority (ESMA), along with national regulators, will determine which "standard" OTC derivatives should be cleared through a CCP. They will take into account criteria including whether the derivatives have common legal documentation, volume, liquidity and the availability of fair, reliable and generally accepted pricing information. In July 2013 ESMA published a discussion paper outlining this procedure in further detail. When these derivatives have been determined and CCPs have been authorised, firms will then need to enter into either direct or indirect clearing arrangements with a CCP to clear these derivatives.

5. What about trades that are not centrally cleared?

OTC derivatives that are not cleared through a CCP can continue to be traded directly between counterparties. However, firms will need to comply with alternative risk mitigation techniques when entering into these types of OTC derivative contracts.

6. I've heard that EMIR applies differently to "financial counterparties" and "non-financial counterparties", is this correct?

This distinction is relevant in relation to the clearing and risk mitigation obligations. It does not make any difference to the trade reporting obligation.

The requirement to clear certain OTC derivatives through a CCP applies automatically to financial counterparties. However, this only applies to non-financial counterparties when they have exposure to OTC derivatives above a certain level, referred to as being a "NFC+".

In relation to the risk mitigation techniques, non-financial counterparties that do not exceed this level, referred to as being "NFC-", will only have to comply with some of the risk mitigation requirements (not all of them). Firms will need to consider whether they are a financial counterparty or a non-financial counterparty, and whether they are an NFC+ or NFC-, in relation to which clearing and risk mitigation obligations apply to them.

7. What are the thresholds between an NFC+ and an NFC-?

Non-financial counterparties will need to consider whether they have exposure to OTC derivatives above the thresholds in the table opposite. When making this calculation, firms are not required to take into account any OTC derivatives that they enter into for hedging purposes. But they must include all OTC derivatives entered into by non-financial counterparties within their group on a global basis. If a non-financial counterparty exceeds the clearing threshold they must notify the Financial Conduct Authority and ESMA.

8. What will firms need to do to satisfy the collateral requirement?

One of the risk mitigation requirements for OTC derivatives that are not cleared through a CCP relates to the exchange of collateral. While there has been much debate at international level, earlier this month the International Organisation of Securities Commissions and the Basel Committee on Banking Supervision published the final framework relating to the exchange of collateral. This confirmed, amongst other things, that parties will be required to exchange both initial and variation margin. These requirements will be implemented in the EU through new binding technical standards which will be consulted on by the European Banking Authority (co-operating with the other European regulators) in due course.

Impact on real estate

For a real estate sector business which is caught by EMIR:

  • standardised swap activities (determined by ESMA) may need to be cleared through CCPs, with appropriate liquid collateral (real estate does not currently count) and reporting; and
  • for swaps that are not cleared through a CCP, it will have to have risk management procedures in place, potentially including the marking-to-market of outstanding contracts on a daily basis.

9. What is the timing of EMIR?

EMIR enters into force on a staged basis. One of the risk mitigation techniques, relating to timely confirmation, entered into force on 15 March 2013. The risk mitigation techniques of portfolio reconciliation, portfolio compression and dispute resolution are scheduled to enter into force on 15 September 2013. The risk mitigation technique relating to the exchange of collateral is not expected to enter into force until 2014 or 2015.

The reporting obligation for credit and interest rate derivatives was scheduled to begin in September 2013, but ESMA recently announced that this has been delayed until 1 January 2014. This is the date from which the reporting obligations relating to the other types of derivatives should also apply. However, this date is dependent on the registration of a TR to accept the relevant trade reports.

With no CCPs having yet been authorised, the clearing obligation is not expected to come into force until 2014 or 2015.

10.How does EMIR fit in with the Alternative Investment Fund Managers Directive (AIFMD)?

EMIR applies differently depending on whether the relevant fund, or structuring entity that enters into OTC derivatives, is classified as an "alternative investment fund" (AIF) under the AIFMD.

AIFs fall within the definition of a financial counterparty. As mentioned above in question 6, this means that the full clearing and risk mitigation obligations would apply when an AIF enters into OTC derivatives (even for hedging purposes).

One important area is who is a "financial counterparty" and therefore within the scope of the more detailed requirements of EMIR. This includes AIFs under AIFMD, as well as banks and other financial institutions

However, any entity in a fund structure that is not an AIF will instead be classified as a non-financial counterparty (including a fund before it is classified as an AIF under the AIFMD). Where these entities enter into OTC derivatives, they will not need to comply with the full clearing and risk mitigation requirements unless they enter into OTC derivatives with a value above the relevant clearing threshold and become an NFC+. As mentioned in question 7, any calculation relating to whether a non-financial counterparty exceeds the clearing threshold would not take into account any OTC derivatives that have been entered into for hedging purposes.

This article was previously published by Compliance Complete by Thomson Reuters Accelus

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.