The race towards a pan-European regulation of over-the-counter (OTC) derivatives, central counterparties and trade repositories is on, with the European Parliament set to meet on 29 March 2012 to vote on the final text of the European Market Infrastructure Regulation (EMIR). Following Parliament approval, the Regulation will pass to a vote in the Council. EMIR is anticipated to apply from the end of 2012.
Once adopted, EMIR will introduce significant changes for the insurance industry by mandating central clearing for standardised OTC derivative contracts and imposing risk mitigation standards for non-centrally cleared contracts. EMIR will apply broadly to interest rate, credit, equity, foreign exchange and commodity OTC derivatives. These rules will result in costly collateral obligations, including posting of initial and variation margin. There will also be wide reporting requirements and related fines. These obligations will apply to all insurers and reinsurers authorised under current EU insurance directives.
A briefing on EMIR and its implications is available here.
A timeline detailing the main steps in the EMIR legislation process is available here.
Key elements of the draft Regulation are summarised below.
- Mandatory Central Clearing: From the end of 2012 all financial entities, including insurance and reinsurance companies, will be required to clear standardised eligible OTC derivative contracts through central counterparties (CCPs). Intragroup transactions are excluded. An entity incorporated outside the EU that would be subject to the clearing obligation if it were established in the EU will also have to abide by the central clearing obligations for transactions with EU entities subject to the clearing obligation, or for any transaction where the contract has a direct, substantial and foreseeable effect within the EU.
- Collateral: Parties to cleared OTC derivative contracts will need to post initial and variation margin.
- CCPs: National competent authorities will be responsible for authorising and supervising CCPs in their jurisdiction. CCPs will be required to have established default procedures in the event of a clearing member’s non-compliance with the rules, and a mutualised default fund to which members of the CCP must contribute.
- Non-Centrally Cleared OTC Derivatives: Non-centrally cleared OTC derivative contracts will be subject to strict procedures to reduce counterparty credit risk and operational risk including the requirement for timely confirmation of terms (where possible by electronic means), robust and auditable processes for portfolio reconciliation, marking to market procedures, dispute resolution, and procedures for the accurate and appropriate exchange of collateral. Again, intragroup transactions are largely sheltered from these requirements.
- Reporting: All counterparties and CCPs must ensure that the details of all derivative contracts, regardless of how they are cleared, are reported without duplication to trade repositories no later than the working day following the conclusion, modification or termination of a contract. The obligation will extend to contracts entered into before the Regulation that are still outstanding on the date of the Regulation’s entry into force. Reporting obligations may be delegated (eg, to prime brokers or asset managers). Trade repositories will publish aggregate positions by class of derivatives. Reporting failures will be met by penalties.
- ESMA: ESMA will have significant responsibility, including (a) identification or approval of contracts subject to clearing and recommendation of clearing thresholds, (b) surveillance of trade repositories, including the grant and withdrawal of their registration, and (c) authorisation and supervision of CCPs from third countries.