Update on EMIR Regulation: Implications for Corporate Users of OTC Derivatives
This note provides a brief outline of relevant issues relating to the European Markets and Infrastructure Regulation (“EMIR”), the new regulation governing the Over the Counter (“OTC”) derivatives markets in Europe. The regulation sets out three main obligations for OTC derivative users, namely:
(i) Central clearing of standardised OTC derivatives (except where exemptions apply)
(ii) Reporting of all OTC derivative transactions to trade repositories
(iii) Risk mitigation for non-cleared derivatives (including collateral posting, prompt exchanges of confirmations, portfolio reconciliation and dispute resolution procedures)
In practical terms, the process of central clearing involves a central counterparty standing in between (intermediating) users of standalone derivatives and regularly exchanging collateral with each of them, which, in theory, has the effect of reducing counterparty credit risk in the derivatives system (i.e. protecting the wider market against negative consequences arising from the failure of a particular “link in the chain”, such as the Lehman Brothers default in 2008).
Non-financial “end users” of OTC derivatives (which includes all corporate users of standalone derivatives, including users of intra-group derivatives) have been granted a restricted exemption from the requirement to clear derivatives which are genuine commercial hedges, largely due to the highly uneconomic effects of having to post collateral against derivative positions on a daily basis. This exemption is subject to an entity’s gross notional amount of derivatives falling below defined “clearing thresholds” (“NFC-” categorisation), which has been set at €3bn in the case of interest rate derivatives. Commercial hedges which are “objectively measurable as reducing risks” do not count toward this threshold calculation (however notably some non-vanilla swaps may count toward the clearing threshold because the commerciality test has been directly linked to qualifying for IFRS hedge accounting). Corporate derivative users with portfolios falling below the €3bn clearing threshold will therefore benefit from the EMIR clearing and margining exemptions.
However, there are still several requirements of the EMIR regulation that apply to all users of standalone derivatives, regardless of their status, and will therefore directly impact corporate derivatives users:
(i) All OTC derivative transactions outstanding at 16th August 2012, or any executed since then, must be reported to a registered trade repository (this applies to all standalone derivatives outstanding since this date)
(ii) There must be a prompt exchange of confirmations between counterparties following any new derivative transaction
(iii) Counterparties must reconcile their derivative positions on a periodic basis
All of these regulations were effective on 16th August 2012, although there is a phase-in period during 2013 and 2014.
The first requirement above has been delayed because no data repositories have yet been established in Europe. The official reporting start date will commence after the registration of the first relevant trade repository, and according to the European Securities and Markets Authority ESMA (http://www.esma.europa.eu/page/European-Market-Infrastructure-Regulation-EMIR) the earliest date that this can occur is 24th September 2013. Should a trade repository be registered on 24th September 2013, the reporting start date would be 1st January 2014, and at that point Corporate derivative users would essentially be required to report all standalone derivatives outstanding at 16th August 2012 (and any executed since then) to the trade repository within 90 days or be in breach of the regulation. After the reporting start date, any new OTC derivative trades should be reported to the trade repository by the end of the next business day.
EMIR permits companies’ reporting obligations to be delegated to their counterparty banks, although companies should seek to confirm this service is available from each of their counterparties. However, the reporting obligation also arises in respect of intra-group derivatives, so any entities which had intra-group swaps in place on or after 16th August 2012 will need to report these positions themselves, or delegate the responsibility to a suitable third party. Entities falling into this category must be able to capture sufficient information on their intra-group derivative positions to complete all the data fields in the reporting form (please see Appendix of EACT report linked below).
The second requirement is that companies must exchange confirmations for any new derivative trade with their counterparty within 2 business days of the execution of the trade. This regulation applied from 15th March 2013 and there is a phase-in period going out to August 2014 – please see EACT link below for more details. However, it may be sensible for clients to assume that the 2 day rule is applicable henceforth so there is no risk of breaching the regulation.
The third requirement is that companies must reconcile their derivatives portfolios with their counterparties at least annually (providing they have less than 100 derivatives contracts outstanding – for more than 100 contracts there is a quarterly reconciliation requirement). The EMIR regulation also requires that counterparties agree in writing the terms on which their portfolios will be reconciled and document a dispute resolution procedure. This regulation is applicable from 15th September 2013.
We recommend that clients incorporate these processes into their treasury policies at the next opportunity and Centrus has drafted EMIR related treasury policy updates for this purpose which we would be pleased to discuss with you further. It is also advisable for Corporate Treasuries to speak to all of their counterparty banks in order to understand their current position on EMIR and also consult their legal advisors if they are concerned about any technical legal aspects of the regulation.
The European Association of Corporate Treasurers (EACT) has played a central role in lobbying on behalf of corporates in favour of exemptions from the EMIR regulation and we recommend reading their comprehensive briefing note on the impact of EMIR on non-financial companies:
Please contact us with any queries or for further information in this area.