European Market Infrastructure Regulation (EMIR) 

All counterparties, both financial and non-financial, that enter into derivative contracts are subject to the European Market Infrastructure Regulation (EMIR), which is aimed at reducing the risks associated with the derivatives market, especially OTC derivatives. The Regulation came into force in August 2012 but hasn’t been fully implemented yet. Many of its provisions are completely new in a market, which by its very nature has dealt with non-standardised financial instruments.

 

EMIR imposes obligations on counterparties in relation to;

  • Reporting - All derivative contracts, including exchange traded derivatives must be reported to a trade repository;
  • Risk management – All non-centrally cleared trades are subject to risk management procedures, including the exchange of collateral;
  • Clearing – Certain derivative contracts (yet to be defined) will need to be cleared by a central counterparty.

 

The reporting and most of the risk mitigation requirements are in place but the central clearing and collateral exchange obligations have yet to take effect. A number of trade repositories and central counterparties have been authorised by ESMA. EMIR has already had implications on operations but when the clearing and collateral exchange obligations take effect, which could be early in 2015, counterparties operating models will need to be reviewed and may need to be adapted to ensure compliance.

 

KPMG has significant expertise and depth of knowledge in helping counterparties comply with these obligations. We have been tracking developments in the evolution of EMIR to help our clients understand not just the detail of how these requirements will affect their business but also to help them put in place the solutions needed to deliver compliance. Please get in touch to find out more about how our services can help your business.

Publications

EMIR Basics
July 2014
 (PDF, 868KB)

EMIR Update
July 2014
 (PDF, 316KB)

What you need to know about EMIR?

EMIR provides for;

 

  • Reporting of all derivative contracts (including exchange traded derivatives to TRs);
  • Mandatory clearing for all standardised derivative contracts;
  • Risk mitigation techniques for non-centrally cleared derivatives;
  • Obligations on both TRs and CCPs.

 

KPMG can conduct impact assessments and strategic analysis and can assist with the implementation of EMIR and with financial engineering.

 

Reporting

EMIR requires all derivative contracts that are concluded, modified or terminated to be reported to a TR. An entity can choose to report to one of six TRs that are currently registered. . The reporting obligation has been phased in as follows:

 

  • For new derivative contracts reporting commenced on 12 February 2014 and reports must be submitted by close of business of the day following the transaction;
  • Trades outstanding on 16 August 2012 and which were still outstanding on 12 February 2014 have to be reported by 13 May 2014; and finally
  • Relevant trades that were outstanding on 16 August 2012 and have matured before 12 February 2014 will have to be reported by 12 February2017.

 

The reporting requirement applies to all derivatives including exchange traded derivatives and intra-group trades. Furthermore from 11 August 2014 FCs and NFCs above prescribed gross notional thresholds [NFCs+] will have to report collateral and daily mark-to-market valuations.

 

Both counterparties must report each trade, but reporting may be delegated to a third party, including the other counterparty or a CCP. However, if reporting is delegated, responsibility for ensuring the accuracy of the data remains with the delegating counterparty.

 

Clearing

Mandatory clearing, via a CCP, will apply to eligible OTC derivative contracts (which have yet to be defined by ESMA) transacted by FCs and NFCs+ . Exemptions will be available for intra-group transactions and for pension scheme arrangements. The exemptions for intra-group transactions will be subject to a review by the competent authority and the exemptions for the pension scheme arrangements will be available until at least August 2015 and this timeframe may be extended by three years.

 

The authorisation of the first CCP - NASDAQ OMX Clearing on 18 March 2014has necessitated the drafting of technical standards on clearing by ESMA. These need to be submitted to the European Commission by 18 September 2014. Following approval of these technical standards, the clearing obligation will take effect between three to ten months later. The standards are likely to specify that phase-in periods may be allowed per type of counterparty. This means that some form of clearing obligation, dependant on the class of derivative and the counterparty classification, is likely to come into effect from early 2015. Two other CCPs have been authorised; EuroCCP NL on 1 April 2014 and EuroCCP on 3 April 2014.

 

Risk Mitigation Techniques

Risk mitigation mechanisms must be put in place by FCs NFCs+ to deal with derivatives which have not been centrally cleared. These include procedures to ensure;

 

  • The timely confirmation of trades. Trades need to be confirmed between the two counterparties involved and the relevant deadlines depend on the type of derivatives being traded and the nature of the counterparties. Counterparties must also have procedures in place to be in a position to report to the national competent authority (NCA) any non-cleared OTC derivative contracts outstanding for more than five business days.
  • The reconciliation of derivative portfolios.  Counterparties must have arrangements in place to reconcile the key terms of non-cleared OTC derivative contracts. The frequency of the reconciliations depends on the number of outstanding contracts and the nature of the counterparties.
  • The compression of larger derivative portfolios. A counterparty which has more than 500 non-cleared OTC derivative contracts outstanding must, at least twice a year, consider whether it needs to conduct a portfolio compression exercise to reduce its counterparty credit risk.
  • The resolution of any disputes between counterparties. Detailed procedures must be in place between counterparties to ensure any disputes which may arise, specifically disputes outstanding for more than five days, are dealt with.
  • The valuation of derivative portfolios. FCs and NFCs+ must mark-to-market or perform an appropriate valuation for non-cleared OTC derivative contracts on a daily basis.
  • The holding of collateral. FCs and NFCs+ will need to have sound risk management procedures in place to allow for timely, accurate and appropriately segregated exchange of collateral for OTC derivative contracts which are not cleared centrally. Technical standards are due to be drafted by ESMA on the amount and type of collateral involved and on the criteria for an intra-group exemption. A consultation paper has been issued by all three European supervisory agencies seeking feedback on this matter. FCs and NFCs+ will also need to hold an appropriate and proportionate amount of capital to manage the risk not covered by appropriate exchange of collateral.

 

Trade Repositories and Central Counterparties

ESMA is responsible for the registration and supervision of TRs. Six TRs have been registered; DTCC Derivatives Repository Limited (U.K.), Krajowy Depozyt Papierow Wartosciowych S.A. (Poland), Regis – TR S.A. (Luxembourg), UnaVista Limited (U.K.), CME Trade Repository Ltd (U.K.), ICE Trade Vault Europe Ltd (U.K.). ESMA has the power to impose fines and penalty payments on trade repositories, with the limitation period for imposition of such fines and penalties being set at five years.

 

ESMA is also responsible for the authorisation of EEA CCPs with the first three EEA CCPs noted above having been authorised. Other EEA CCPs in the process of being authorised include; London Clearinghouse, ICE Clear, Eurex and CME. Non-EEA CCPs providing clearing services to clearing members or trading venues must be recognised by ESMA. The NCAs will organise colleges to ensure the consistent supervision of CCPs.

 

Reducing the complexity of EMIR compliance

In addition to the short time frame for implementation, the impact of the Regulation is considerable for all parties involved in OTC derivative transactions. KPMG has been tracking developments in the evolution of EMIR requirements and some of the significant points to emerge include;

 

1. Department of Finance Consultation

The Department of Finance consulted on Member State discretions within EMIR in a consultation which closed on 14 March 2014. It is intended that the Central Bank be appointed the NCA for the purposes of EMIR.

 

Issues under consideration included the powers of the NCA and the sanctions regime. Proposed measures made use of structures and legislation already in place for regulated entities, for example in the administrative sanctions regime and in markets legislation, which will be new to NFCs.

 

It is proposed that counterparties will have to compile a Statement of Compliance (SoC) to attest compliance with EMIR. This SoC will need to be verified by a third-party, for example the external auditor. It is intended that the Central Bank will issue technical guidelines on how to compile and certify the SoC. There may be an exemption for NFCs with little trading activity, however the nature of this exemption still has to be determined.

 

Department of Finance EMIR Public Consultation document

 

2. Central Bank

Whilst the Central Bank has not yet been designated as the NCA in Ireland, in anticipation of this designation it has set up an EMIR Unit to ensure that it is operationally prepared for the implementation of the Regulation. The supervision of EMIR compliance for existing regulated counterparties will be conducted by the particular sector supervisory areas and the EMIR Unit will supervise NFCs which are not subject to other financial regulations. Further information is available at the following website: http://www.centralbank.ie/regulation/EMIR/Pages/EMIRRegulation.aspx

 

3. Reporting

Reporting commenced on 12 February 2014. Reports require both Legal Entity Identifier codes (LEI) and Unique Trade Identifier codes (UTI). As LEI codes are not yet available, the use of pre-LEI codes has been permitted instead, which in time will transform into LEI Codes. Pre-LEI codes can be obtained from the Irish Stock Exchange (or any other approved pre-Local Operating Units provider). Alternatively BIC or CICI codes can be used to identify the entity involved. Reports can be furnished to any number of TRs, therefore a single entity could report different trades to different TRs.

 

Since 12 February reporting has proven to be problematic. Whilst the technology is in place to deal with the volumes of trades involved, I.T. systems to match up trades are heavily reliant on the quality of the data submitted. It is anticipated that it will take at least another few weeks for the process to run smoothly and for all trades to be correctly identified and matched.

 

4. Cross Border Application of EMIR

Third country counterparties can be indirectly affected by EMIR in that if they enter into derivative contracts with EU counterparties, they must be able to facilitate the EU counterparty’s compliance with EMIR requirements.

 

EMIR also applies to contracts between two third country entities that would be subject to the clearing or the risk mitigation obligations if they were established in the EU, provided the contract has a “direct, substantial and foreseeable effect within the EU” or “where such an obligation is necessary or appropriate to prevent the evasion of any provisions of EMIR”. The European Commission has just adopted regulatory technical standards specifying which types of contracts are subject to EMIR for counterparties located in a third country where the  legal, supervisory and enforcement arrangements have not been declared equivalent for the purposes of EMIR.

 

In 2013, ESMA published technical advice on its equivalence assessments of Canada, India, South Korea, Australia, Hong Kong, Singapore, Switzerland, U.S. and Japan. The Commission is expected to adopt this technical advice on a conditional equivalence basis, whereby it may waive certain EMIR rules in favour of equivalent third country rules rather than granting or not granting equivalence to the third country regime as a whole.

 

5. Definition of derivatives for the purposes of EMIR

EMIR aligns the definition of derivative contracts with the list of financial instruments in the Markets in Financial Instruments Directive (MiFID). Under MiFID, different treatments for FX forward contracts and commodity forward contracts have arisen depending on national interpretations and this means these instruments are not being treated consistently across Europe for the purposes of EMIR. ESMA issued a letter to the European Commission seeking clarification on the exact definition of a forward contract, specifically for FX forwards with a settlement date up to seven days, FX forwards concluded for commercial purposes and physically settled commodity forwards. The European Commission has now issued a consultation on this matter and has indicated it will reflect any changes in upcoming legislation on MiFID II.

 

Why non-financial counterparties should be concerned with EMIR?

The Regulation applies to both FCs and NFCs bringing most NFCs into the regulatory net for the first time. KPMG has been working with NFCs to navigate through these requirements and to assess their impact on the NFCs business.

 

The obligations that apply as outlined already include;

 

  • Reporting obligations to a TR (albeit they can be delegated to a third party);
  • Risk mitigation techniques for non-centrally cleared trades (except the requirement to exchange collateral and value derivative portfolios); and
  • Clearing of OTC derivative contracts that are subject to the clearing obligation (yet to be defined) if the NFC exceeds prescribed gross notional thresholds.

 

The clearing threshold is an amount set by class of OTC derivative contracts by ESMA;

 

Value of the clearing threshold levels

€1 billion*

Credit derivative contracts

€1 billion*

Equity derivative contracts

€3 billion*

Interest rate derivative contracts

€3 billion*

Foreign exchange derivative contracts

€3 billion*

Commodity derivative contracts and others

 

*gross notional value

 

NFCs below prescribed gross notional thresholds (NFCs-) are not obliged to clear OTC derivative contracts even if the counterparty is an FC or an NFC+.

 

OTC derivative contracts entered into to hedge risks or which qualify as hedging contracts under accounting standards are not included for the purposes of calculating the threshold level. Once one threshold level is breached then the clearing obligation applies to all OTC derivative contracts.

 

All OTC derivative contracts entered into by NFCs within a group are included in the calculation of the threshold level. However, where intra-group transactions take place they may be exempt from clearing when certain conditions are met (including notification to or authorisation by the relevant competent authority).

 

A notification requirement is in place, since 15 March 2013, whereby NFCs need to notify ESMA as to whether or not they have exceeded the threshold levels.

 

Contact us

paul o'connor, director

Paul O'Connor

Director

paul.oconnor@kpmg.ie

+353 1 700 4038

Request for proposal – RFP

We can assist with the issues your business is facing and provide the services you require.

 

Click here to submit an RFP.

Share this page