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 four key things that Irish banks 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.

2. Immediate requirement to calculate the clearing threshold EMIR Refit provides that where a financial counterparty 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 financial counterparty 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 banks. Banks 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 bank 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. Financial counterparty legally liable for EMIR Reporting EMIR Refit amends EMIR to provide that, from 18 June 2020, financial counterparties “shall be responsible, and legally liable” for reporting the details of OTC derivative contracts entered into with an NFC- (meaning an NFC below the clearing thresholds). The financial counterparty is responsible for reporting on behalf of both counterparties. The NFC- will remain responsible for providing the financial counterparty with the details which the financial counterparty cannot be reasonably expected to possess and for ensuring that those details are correct.

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. Financial counterparties 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.