Shifting Obligations: Limited Time

EMIR Refit will enter into force on 17 June 2019 and will amend the existing EMIR legislation applicable to European counterparties trading derivatives, with the express aim of simplifying the EMIR regime to make the compliance burden more proportionate. We set out below the five key things that Irish funds and their UCITS ManCos and AIFMS (“Managers”) need to know about EMIR Refit.

1. Small financial counterparty (“SFC”) clearing exemption EMIR Refit introduces a new SFC category, which is a financial counterparty whose positions in OTC derivatives fall below the relevant clearing thresholds under EMIR. SFCs are not subject to the mandatory clearing obligation under EMIR. When determining whether the clearing thresholds have been exceeded, a financial counterparty must calculate its aggregate month-end average notional position in OTC derivatives for the previous 12 months. This is understood to mean the sum of all positions (for the relevant class of derivatives) at the end of each month, divided by 12.

For UCITS and AIFs, EMIR Refit is clear that the positions shall be calculated at the level of the fund. Managers which manage more than one fund must be able to demonstrate to the relevant competent authority that the calculation of the clearing threshold at the fund level does not lead to:

(a) a systematic underestimation of the positions of any of the funds they manage or the positions of the Manager; and (b) a circumvention of the clearing obligation.

2. Immediate requirement to calculate the clearing threshold EMIR Refit provides that where a financial counterparty (such as a UCITS or AIF) exceeds the clearing threshold or chooses not to calculate its positions relative to the clearing threshold on the day EMIR Refit takes effect they must immediately notify ESMA and the relevant competent authority. In such circumstances, the UCITS or AIF will become subject to the clearing obligation for OTC derivative contracts entered into, or novated, as from four months following that notification.

On 28 March 2019 ESMA issued a statement explaining that the new clearing threshold requirement will become effective immediately once EMIR Refit comes into force. Therefore, the results of the calculation must be available on 17 June 2019. ESMA stated that financial counterparties are “expected to collect all the necessary data and information for the calculation in the meantime, in order to be ready for the calculation…”.

This constitutes an onerous obligation for funds and their Managers. Managers now have a very short window of time to conduct the calculation of the relevant group month-end position for the previous 12 months, ending on 31 May 2019. If an Irish fund does not, for any reason, perform the calculation on 17 June 2019, then it must immediately notify ESMA and the Central Bank of Ireland and prepare to commence clearing all relevant asset classes four months later.

3. Manager legally liable for EMIR Reporting EMIR Refit amends EMIR to provide that, from 18 June 2020, the Manager “shall be responsible, and legally liable” for reporting the details of OTC derivative contracts entered into by the fund. This alters the pre-existing position, which was that the fund is responsible for reporting.

The Central Bank of Ireland has been focussing on the accuracy of EMIR reporting as indicated by the recent “Dear Director” letter sent to derivatives users. Managers will need to ensure that they have adequate procedures in place to ensure initial and ongoing monitoring of the accuracy of EMIR reports and could face Central Bank of Ireland sanctions for failure to do so.

4. Central Bank of Ireland pre-approval of risk mitigation techniques EMIR Refit amends EMIR to provide that the Regulatory Technical Standards specifying risk-management procedures relating to the exchange of margin must include “supervisory procedures to ensure initial and ongoing validation of those risk-management procedures”. Recital 20 of the EMIR REFIT Proposal further states that: “[t]o avoid inconsistencies across the Union in the application of the risk-mitigation techniques, due to the complexity of the risk-management procedures requiring the timely, accurate and appropriately segregated exchange of collateral of counterparties which involve the use of internal models, competent authorities should validate those risk-management procedures or any significant change to those procedures, before they are applied.”

This obligation will apply from 12 months after the entry into force of EMIR Refit. While the scope of this obligation is currently unclear, the requirement that the Central Bank of Ireland conduct an initial pre-approval and ongoing validation of the collateralisation procedures applied by in-scope derivatives counterparties would constitute a major change to current market practice, particularly in light of the Central Bank of Ireland moving away from reviewing risk management procedures in recent times.

5. Expanded scope of AIFs subject to EMIR EMIR Refit expands the scope of AIFs which are considered to be financial counterparties to include an AIF which is either established in the EU or managed by an AIFM authorised or registered in accordance with AIFMD, unless that AIF is set up exclusively for the purpose of serving one or more employee share purchase plans, or unless that AIF is a securitisation special purpose entity as referred to in Article 2(3)(g) of AIFMD and, where relevant, its AIFM is established in the EU.

This means that EU-based AIFs will now be considered financial counterparties even where their AIFMs are not authorised or registered under AIFMD (whereas previously such AIFs could be considered non-financial counterparties under EMIR). In addition, where an EU entity trades with a non-EU AIF not otherwise caught directly by EMIR, the EU entity will now have to treat the non-EU AIF as equivalent to a financial counterparty (unless either of the employee share purchase plan or SSPE exemptions apply).