The European Commission adopted on 4th July 2012 nine regulatory and implementing technical standards to complement the obligations defined under the Regulation on OTC derivatives, central counter-parties (CCPs) and trade repositories, which constitute the European Markets Infrastructure Regulation (EMIR) and have been developed by the European Supervisory Authorities. They have been endorsed by the European Commission without modification and entered into force on 16th August 2012 as Level 1 text. The adoption of these standards follows the EU’s G20 commitment made in Pittsburgh in September 2009.
\nESMA (European Securities and Markets Authority) is \u201a\u00c4\u00faan independent EU Authority that contributes to safeguarding the stability of the European Union’s financial system by ensuring the integrity, transparency, efficiency and orderly functioning of securities markets, as well as enhancing investor protection\u201a\u00c4\u00f9.
\nThe main general purpose of ESMA is to ensure the correct functioning across the financial markets in Europe by providing a consistent investor protection and international supervisory co-operation.
\nSpecifically for EMIR, ESMA developed the \u201a\u00c4\u00faDraft Technical Standards for the Regulation on OTC Derivatives, CCPs and Trade Repositories\u201a\u00c4\u00f9 (Level 2 text) which are considered subordinate acts and executive measures giving effect to the substantive requirements (in this case to the Regulation (EU) No 648\/2012), referred as draft regulatory (RTS) and implementing technical standards (ITS) in relation to several provisions of EMIR.
\nWhy? The need for this Regulation.
\nThe year 2008 was a landmark in the economy historical annals. The worst financial crisis since the Great Depression of the 1930s hit the world dramatically. The watershed moment \u201a\u00c4\u00ec the collapse of Lehman Brothers (along with those of AIG and Bear Sterns) because it held on to large positions in subprime and other lower-rated mortgage tranches when securitizing the underlying mortgages \u00ac\u2020(like CDOs \u201a\u00c4\u00b6) and causing a liquidity issue, exposed the fragility of the OTC derivatives world, which constituted the cause of that disaster. Fundamentally, two are the main reasons: even if the OTC world accounts for around $27 trillion in terms of gross market value (for a more in depth analysis of the size of the OTC market, \u00ac\u2020see\u00ac\u2020https:\/\/theotcspace.com\/2013\/03\/22\/how-big-is-otc-really\/), the potential losses that OTC derivatives can generate through \u201a\u00c4\u00faleverage\u201a\u00c4\u00f9 \u00ac\u2020could be gigantic; and it demonstrated to be very opaque.
\nThe following year in Pittsburgh at the G\u201a\u00c4\u00ec20, a group of nations agreed on a set of rules to increase transparency and reduce systemic risk. The European Market Infrastructure Regulation (EMIR) represents the response to the commitments on behalf of the EU nations; with the same end, the US has enforced the \u201a\u00c4\u00faDodd\u201a\u00c4\u00ecFrank Wall Street Reform and Consumer Protection Act\u201a\u00c4\u00f9 (Dodd\u201a\u00c4\u00ecFrank Act) and the Japanese Financial Service Authority (JFSA) had implemented similar requirements.
\nWho? The parties involved.
\nEMIR divides counterparties into the following four categories: Financial Counterparties, Non-Financial Counterparties, Central Counterparties and Trade Repositories.
\nThe following are the general definition provided by EMIR, which will help you to identify what category you fall into.
\nFinancial Counteparties (FCs), \u00ac\u2020as defined in Article 2 (8) of Regulation (EU) No. 648\/2012
\nan investment firm authorised in accordance with\u00ac\u2020Directive 2004\/39\/EC;
\na credit institution authorised in accordance with\u00ac\u2020Directive 2006\/48\/EC;
\nan insurance undertaking authorised in accordance with\u00ac\u2020Directive 73\/239\/EEC;
\nan assurance undertaking authorised in accordance with\u00ac\u2020Directive 2002\/83\/EC;
\na reinsurance undertaking authorised in accordance with\u00ac\u2020Directive 2005\/68\/EC;
\na UCITS [Undertakings for Collective Investment in Transferable Securities] and, where relevant, its management company, authorised in accordance with\u00ac\u2020Directive 2009\/65\/EC;
\nan institution for occupational retirement provision within the meaning of Article 6(a) of\u00ac\u2020Directive 2003\/41\/EC; and
\nan alternative investment fund managed by AIFMs\u00ac\u2020 [Alternative Investment Fund Managers] authorised or registered in accordance with\u00ac\u2020Directive 2011\/61\/EU.
\nNon\u201a\u00c4\u00ecFinancial Counterparties (NFCs), as defined in Article 2 (9) of Regulation (EU) No. 648\/2012
\n\u201a\u00c4\u00f2Non-financial counterparty\u201a\u00c4\u00f4 means an undertaking established in the Union other than the entities referred to in points 1 (Central Counterparties) and 8 (Financial Counterparties).
\nFor scoping purposes, NFCs are divided into those above the clearing thresholds (see below) and those ones below. Those ones that breach the threshold are considered as FCs and subject to the full extent of the regulation.
\nThe clearing thresholds are defined in the Article 10 (3) of Regulation (EU) No. 648\/2012 and are defined per asset classes: credit derivatives, equity derivatives, interest rate, foreign exchange and commodity and others, as follows:
\nEUR 1 billion in gross notional value of OTC derivative contracts for each of the credit and equity derivative contracts;
\nEUR 3 billion in gross notional value of OTC derivative contracts for each of the interest rate, foreign exchange, and commodity or others derivative contracts.
\nWhen one of the clearing thresholds is reached, the entity is considered as exceeding the clearing thresholds and therefore subject to the relevant EMIR requirement for all classes of OTC derivative contracts.
\nFor additional information, ESMA created a document specifically for Non\u201a\u00c4\u00ecFinancial Counterparties:\u00ac\u2020What does EMIR mean for Non-financial counterparties?
\nCentral Counterparties\u00ac\u2020(CCPs), are mentioned in Article 2 (1) of Regulation (EU) No. 648\/2012
\n\u201a\u00c4\u00f2CCP\u201a\u00c4\u00f4 means a legal person that interposes itself between the counterparties to the contracts traded on one or more financial markets, becoming the buyer to every seller and the seller to every buyer.
\nLastly,\u00ac\u2020Trade Repositories\u00ac\u2020(TRs), are outlined in Article 2 (2) of Regulation (EU) No. 648\/2012
\n\u201a\u00c4\u00f2Trade repository\u201a\u00c4\u00f4 means a legal person that centrally collects and maintains the records of derivatives.
\n\u00ac\u2020Which? The financial products in scope.
\nThe products are mainly divided into Derivatives and OTC derivatives and the difference between the two categories are defined by EMIR as below\u00ac\u2020(for an extensive regression on Financial Products you can refer to our ‘The Knowledge’ page for\u00ac\u2020Products).
\nDerivatives\u00ac\u2020 (Article 2 (5) of Regulation (EU) No. 648\/2012)
\n\u201a\u00c4\u00f2Derivative\u201a\u00c4\u00f4 or \u201a\u00c4\u00f2derivative contract\u201a\u00c4\u00f4 means a financial instrument as set out in points (4) to (10) of Section C of Annex I to Directive 2004\/39\/EC as implemented by Article 38 and 39 of Regulation (EC) No 1287\/2006.
\nAs point of reference, please see below the extract from the regulatory piece mentioned:
\nOptions, futures, swaps, forward rate agreements and any other derivative contracts relating to securities, currencies, interest rates or yields, or other derivatives instruments, financial indices or financial measures which may be settled physically or in cash;
\nOptions, futures, swaps, forward rate agreements and any other derivative contracts relating to commodities that must be settled in cash or may be settled in cash at the option of one of the parties (otherwise than by reason of a default or other termination event);
\nOptions, futures, swaps, and any other derivative contract relating to commodities that can be physically settled provided that they are traded on a regulated market and\/or an MTF;
\nOptions, futures, swaps, forwards and any other derivative contracts relating to commodities, that can be physically settled not otherwise mentioned in C.6 and not being for commercial purposes, which have the characteristics of other derivative financial instruments, having regard to whether, inter alia, they are cleared and settled through recognised clearing houses or are subject to regular margin calls;
\nDerivative instruments for the transfer of credit risk;
\nFinancial contracts for differences.
\nOptions, futures, swaps, forward rate agreements and any other derivative contracts relating to climatic variables, freight rates, emission allowances or inflation rates or other official economic statistics that must be settled in cash or may be settled in cash at the option of one of the parties (otherwise than by reason of a default or other termination event), as well as any other derivative contracts relating to assets, rights, obligations, indices and measures not otherwise mentioned in this Section, which have the characteristics of other derivative financial instruments, having regard to whether, inter alia, they are traded on a regulated market or an MTF, are cleared and settled through recognised clearing houses or are subject to regular margin calls.
\nOTC Derivatives\u00ac\u2020(Article 2 (7) of Regulation (EU) No. 648\/2012)
\n\u201a\u00c4\u00f2OTC derivative\u201a\u00c4\u00f4 or \u201a\u00c4\u00f2OTC derivative contract\u201a\u00c4\u00f4 means a derivative contract the execution of which does not take place on a regulated market as within the meaning of Article 4(1) (14) of Directive 2004\/39\/EC (see footer 3) or on a third-country market considered as equivalent to a regulated market in accordance with Article 19(6) of Directive 2004\/39\/EC.
\nIt is considered a regulated market, “a multilateral system operated and\/or managed by a market operator, which brings together or facilitates the bringing together of multiple third-party buying and selling interests in financial instruments – in the system and in accordance with its non-discretionary rules – in a way that results in a contract, in respect of the financial instruments admitted to trading under its rules and\/or systems, and which is authorised and functions regularly [\u201a\u00c4\u00b6]”.
\nWhat? General overview of the main requirements.
\nA matrix of the obligations based on product and type of counterparty can be found below as brief overview.\u00ac\u2020
\nCentral Clearing for certain asset classes of OTC derivatives
\nThe process of central clearing can be defined as the interposition of a third party into a bilateral trade, in which the third party becomes the seller to every buyer and the buyer to every seller.
\nEMIR defines the criteria that ESMA shall adopt for determining what asset classes and OTC derivatives instruments should be subject to the obligation of central clearing. ESMA will publish a list of those OTC derivatives in scope for clearing, based on:
\nDegree of Standardisation;
\nLiquidity;
\nAvailability of reliable pricing.
\nThere are few issues correlated with the (nonappearance) of the above criteria. Firstly, standardisation will attract a greater trading interest and the product will be more liquid. Liquidity not only has a great effect on the CCP\u201a\u00c4\u00f4s Risk Management for the increased accuracy in valuation of positions but also it will impact the accuracy of time-series data by enhancing the processes of development, testing and calibration of risk models. Lastly, a liquid market allows the CCP to hedge the risk on defaulter\u201a\u00c4\u00f4s portfolio by entering into an equal and opposite position in those contracts.
\nTwo methods are to be used by ESMA during the selection process of the products: Bottom-up (according to which, when a competent authority authorises a CCP to clear a class of OTC derivatives, it will notify ESMA) and Top-down (according to which ESMA has to identify the classes of OTC derivatives that meet the same criteria specified below, but for which no CCP has received an authorisation).
\nOn 12th\u00ac\u2020July 2013, ESMA has published a Discussion Paper on \u201a\u00c4\u00faThe clearing obligation under EMIR\u201a\u00c4\u00f9 with the main purpose of receiving feedback prior to the drafting of regulatory technical standards. All stakeholders are invited by the commission to respond with a\u00ac\u2020Template for the Responses to the Discussion Paper on the Clearing Obligation under EMIR.
\nApplication of\u00ac\u2020Risk Mitigation Techniques\u00ac\u2020for non-centrally cleared OTC derivatives:
\nIn Art. 11 of Regulation (EU) No. 648\/2012, the regulator outlines the minimum requirements for those not cleared trades \u201a\u00c4\u00faFCs and NFCs that enter into an OTC derivative contract not cleared by a CCP, shall ensure, exercising due diligence, that appropriate procedures and arrangements are in place to measure, monitor and mitigate operational risk and counterparty credit risk, including at least:
\nThe timely confirmation, where available, by electronic means, of the terms of the relevant OTC derivative contract;
\nFormalised processes which are robust, resilient and auditable in order to reconcile portfolios, to manage the associated risk and to identify disputes between parties early and resolve them, and to monitor the value of outstanding contracts\u201a\u00c4\u00f9.
\nIn addition, FCs and NFCs \u201a\u00c4\u00fashall mark-to-market on a daily basis the value of outstanding contracts\u201a\u00c4\u00f9 and \u201a\u00c4\u00fashall have risk management procedures that require the timely, accurate and appropriately segregated exchange of collateral with respect to OTC derivative entered into or after 16th\u00ac\u2020August 2012\u201a\u00c4\u00f9.
\nLastly \u201a\u00c4\u00faFCs shall hold an appropriate and proportionate amount of capital to manage the risk not covered by appropriate exchange of collateral\u201a\u00c4\u00f9.
\nEMIR instructs ESMA to define intragroup exempt transactions and the details of the information on exempted intragroup transactions.
\nReporting to Trade Repositories
\nThe reporting requirement is outlined by the Art. 9 of Regulation (EU) No. 648\/2012: \u201a\u00c4\u00facounterparties and CCPs shall ensure that the details of any derivative contract they have concluded and of any modification or termination of the contract are reported to a trade repository registered [\u201a\u00c4\u00b6]. The details shall be reported no later than the working day following the Conclusion, modification or termination of the contract.\u201a\u00c4\u00f9
\nThe reports must specify:
\nThe parties to the derivative contract and, where different, the beneficiary of the rights and obligations arising from it;
\nThe main characteristics of the derivative contracts, including their type, underlying maturity, notional value, price, and settlement date.
\nIn addition, \u201a\u00c4\u00faA counterparty which is subject to the reporting obligation may delegate the reporting of the details of the derivative contract\u201a\u00c4\u00f9; however, \u201a\u00c4\u00facounterparties shall ensure that the details of their derivative contracts are reported without duplication.\u201a\u00c4\u00f9
\nApplication of organisational, conduct of business and prudential requirements for CCPs (only applicable to CCPs):
\nThe Regulation (EU) No. 648\/2012 includes the requirement for the application process and the standards for CCPs, as follows:
\nAuthorisation of a CCP and Supervision of a CCP (Art.14 \u201a\u00c4\u00ec 24, including Capital Requirements, procedures for granting and refusing authorisation\u201a\u00c4\u00b6);
\nRequirements for CCPs (Art. 26 \u201a\u00c4\u00ec 35, including General Provisions, Senior Management and the Board, Risk committee, Record keeping and Information to competent authorities, Conflict of Interest \u201a\u00c4\u00b6);
\nConduct of Business Rules (Art. 36 \u201a\u00c4\u00ec 39, including Participation requirements, Transparency, Segregation and Portability);
\nPrudential Requirements (Art. 40 \u201a\u00c4\u00ec 50) are the following: Exposure management, Margin Requirements, Default Fund, Liquidity Risk controls,
\nDefault Waterfall, Investment Policy, Default Procedures, Review of Models, Stress Testing and Back Testing and Settlement.
\nApplication of Requirements for TRs, including the duty to disclose certain data available to the public and to the relevant authorities (only applicable to Trade Repositories):
\nSimilarly to the CCP requirements, EMIR set out obligations and processes for TRs, as below:
\nRegistration and Supervision of Trade Repositories (Art. 55 \u201a\u00c4\u00ec 77);
\nRequirements for Trade Repositories (Art. 78 \u201a\u00c4\u00ec 84) includes the following:\u00ac\u2020 General Requirements, Safeguarding and Recording, Transparency and Data availability
\nIn particular, it is relevant to note that TRs are instructed to \u201a\u00c4\u00faregularly, and in an easily accessible way, publish aggregate positions by class of derivatives on the contracts reported to it\u201a\u00c4\u00f9.
\n\u00ac\u2020When? The timeline.
\nTable of EMIR indicative timeline (source: esma.europa.eu \u201a\u00c4\u00ec updated on 13th\u00ac\u2020September 2013)
\nThe Regulation (EU) No 648\/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties (CCPs) and trade repositories (TRs) (EMIR) entered into force on 16th\u00ac\u2020August 2012. Sequentially, the Commission Delegated Regulations (EU) No 148\/2013 to 153\/2013 of 19th\u00ac\u2020December 2012 (supplementing EMIR) were published in the Official Journal on 23 February 2013 and entered into force on 15th\u00ac\u2020March 2013.
\nThe various deadlines are defined as follows:
\nClearing:\u00ac\u2020the deadline for clearing will depend on the CCP authorisation given by the national competent authorities (NCA). CCPs have a window of six months from 15th\u00ac\u2020March 2013 to apply for the authorisation. Once the application has been submitted, the NCA will take an additional six months to authorise the CCP. Within six months after the first CCP authorisation, ESMA will submit a draft of Regulatory Technical Standards (RTS) on the clearing obligations.
\nRisk mitigation techniques:\u00ac\u2020as far as the timely confirmation is concerned, such requirements apply from the 15th\u00ac\u2020March 2013 (i.e. the date of entry into force of the Delegated Regulations); whilst the dispute resolution, portfolio reconciliation and portfolio compression obligations will take effect on 15th\u00ac\u2020September 2013, with a delay of six months.
\nReporting:\u00ac\u2020the deadline for reporting is based on the Registration date of the first Trade Repository. TRs can send the application from 15th\u00ac\u2020March 2013 and the registration will take place after sixty to sixty-five days, i.e. 23rd\u00ac\u2020September. However, there has not been any registration yet and the earliest deadline as of today is set for 12th\u00ac\u2020February 2013. An article published by Risk.net dares to suggest that the Reporting obligation may be delayed by ESMA until 2015 due to concerns over delegated reporting (Emir flaws could see futures reporting delayed till 2015).<\/p>\n","protected":false},"excerpt":{"rendered":"
The European Union regulation on derivatives, central counterparties and trade repositories. EMIR introduces new requirements to improve transparency and reduce the risks associated with the derivatives market. EMIR also establishes common organisational, conduct of business and prudential standards for CCPs and trade repositories. EMIR is Europe\u201a\u00c4\u00f4s response to the commitments agreed at the G20 2009 Pittsburgh Summit.<\/p>\n","protected":false},"template":"","meta":{"_acf_changed":false},"knowledge_category":[4250],"acf":[],"_links":{"self":[{"href":"https:\/\/theotcspace.com\/wp-json\/wp\/v2\/knowledge_item\/165565"}],"collection":[{"href":"https:\/\/theotcspace.com\/wp-json\/wp\/v2\/knowledge_item"}],"about":[{"href":"https:\/\/theotcspace.com\/wp-json\/wp\/v2\/types\/knowledge_item"}],"wp:attachment":[{"href":"https:\/\/theotcspace.com\/wp-json\/wp\/v2\/media?parent=165565"}],"wp:term":[{"taxonomy":"knowledge_category","embeddable":true,"href":"https:\/\/theotcspace.com\/wp-json\/wp\/v2\/knowledge_category?post=165565"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}