Background

As an EU Regulation with EEA relevance, EMIR1 has direct effect in EEA Member States.  It is the European implementation of the 2009 G20 summit commitments to improve over-the-counter (“OTC”) derivatives markets through the clearing of standardised OTC derivative contracts through central counterparties, their reporting to trade repositories, the imposition of higher capital requirements on non-centrally cleared OTC derivative contracts and the implementation of certain other risk mitigants.

Applicable to all derivatives market participants operating within the EEA, EMIR imposes obligations on such participants in three principal areas:

  • clearing of standardised OTC derivative contracts;
  • reporting of OTC derivative contracts; and
  • employing risk mitigation techniques  in respect of non-cleared OTC derivative contracts.

EMIR came into force on 16 August 2012 and has direct effect throughout the EEA, although its provisions take effect on a phased basis.  Many of the substantive EMIR obligations applicable to non-cleared OTC derivative contracts are now in effect, for example:

  • timely  confirmation  obligations  took effect on 15 March 2013;
  • portfolio compression, portfolio reconciliation and dispute resolution obligations took effect on 15 September 2013;
  • reporting obligations have been taking effect on a phased basis since 12 February 2014, by reference to the information required to be reported and the contracts in respect of which reporting was required (the latter depending on when the contract was entered into and whether, if entered into prior to 12 February 2014, it was still  in effect on that date).

Clearing of Interest Rate OTC Derivatives

EMIR does not set out a definitive timetable for the implementation of the central clearing obligation in respect of derivative contracts; instead it sets out a procedure for its implementation.  In accordance with this procedure ESMA2 issued, and submitted to the European Commission, final draft regulatory technical standards (“RTS”) for the central clearing of interest rate OTC derivatives (“IRS”) on 1 October 2014, defining the:

  • types of IRS contracts which will have to be centrally cleared;
  • types of counterparties covered by the obligation; and
  • dates by which central clearing of those IRS contracts will become mandatory for those  counterparties.

The European Commission has up to three months from receipt to endorse the draft IRS RTS and, if it endorses them without amendment, the draft IRS RTS will be passed to the European Parliament and Council. If the Parliament and Council do not object to the draft IRS RTS within the prescribed period (or confirm to the Commission that they have no objection before expiry of that period), the IRS RTS will be published in the Official Journal and enter into force on the date specified therein being, in the draft IRS RTS, 20 days after that publication.  Assuming endorsement without amendment and no objections, the IRS RTS are likely to enter into force during February 2015.

As regards the classes of IRS covered, they comprise basis swaps, fixed-to- float interest rate swaps, forward rate agreements and overnight index swap but, reflecting the fact that recital (16) to EMIR provides that “[i]n determining which classes of OTC derivative contracts are to be subject to the clearing obligation, ESMA should take into account the specific nature of OTC derivative contracts which are concluded with covered bond issuers or with cover pools for covered bonds”, exclude contracts associated to covered bonds when such contracts satisfy all of the following specified conditions:

  • they are not terminated in case of resolution or insolvency of the covered bond issuer;
  • the derivative counterparty ranks at least pari-passu with the covered bond holders except when the derivative counterparty (i) is the defaulting or the affected party, or (ii) waives the pari-passu rank;
  • they are registered or recorded in the cover pool of the covered bond in accordance with national covered bond legislation;
  • they are used only to hedge the interest rate or currency mismatches of the cover pool in relation with the covered bond;
  • the covered bond to which they are associated meets the requirements of Article 129 of Regulation (EU) No 575/20133; and
  • the covered bond to which they are associated is subject to a regulatory collateralisation requirement of at least 102%.

The draft IRS RTS establish a phased implementation schedule for IRS clearing, depending on whether either4 of the parties to the IRS falls within one of the following four categories:

  • Category 1: clearing members, within the meaning of Article 2(14) of the EU EMIR Regulation, for at least one of the classes of IRS to be centrally cleared, of a central counterparty (“CCP”) that is authorised or recognised in accordance with EMIR before the IRS RTS enter into force - six months after the IRS RTS enter into force (estimated August 2015);
  • Category 2: an EMIR “financial counterparty” (FC) or an alternative investment fund (AIF) that is an EMIR non-financial counterparty that is above the clearing threshold (NFC+) and which:
    • is not within Category 1; and
    • belongs to a group whose aggregate month-end average notional amount of non-centrally cleared derivatives for the three months preceding the entry into force of the IRS RTS, excluding the month of its entry into force, is above EUR 8 billion. All such derivatives, including foreign exchange forwards, swaps and currency swaps, are to be included for this purpose,
    • 12 months after the IRS RTS enter into force (estimated February 2016);
  • Category 3: a FC or NFC+ AIF which is not within Categories 1 or 2 - 18 months after the RTS enter into force (estimated August 2016);
  • Category 4: a NFC+ which is not within any of Categories 1 to 3 - three years after the IRS RTS enter into force (estimated February 2018).

The obligation to “frontload5 IRS applies only  to  counterparties  within  Categories 1 to 3 and applies differently between counterparties within Categories 1 and 2 and those within Category 3. In the case of Category 3 counterparties, the IRS proposed at consultation stage to be captured have been modified with a view to minimising the number of such counterparties’ IRS that will be subjected to frontloading.

The draft IRS RTS now propose that frontloading for Category 3 counterparties will apply only to contracts with a minimum remaining maturity of:

  • 50 years for basis swaps and fixed-to- float IRS classes; and
  • 3 years for forward rate agreements and overnight index swap classes.

The draft IRS RTS have not changed the minimum remaining maturity for contracts to be frontloaded by Category 1 and Category 2 counterparties; the applicable minimum remaining maturity for such counterparties’ contracts entered into or novated before the date of publication of  the IRS RTS in the Official Journal, being:

  • 49 years and 6 months for basis swaps and fixed-to-float IRS classes;
  • 2 years and 6 months for forward rate agreements and overnight index swap classes,

and, for contracts entered into or novated on or after such date of publication, 6 months.

FX Clearing Consultation

ESMA launched a consultation on draft RTS for the clearing of various classes of foreign-exchange non-deliverable forwards (“FX”), excluding contracts associated to covered bonds when such contracts satisfy all of the conditions specified  above with respect to the draft IRS RTS. ESMA proposes, in respect of the FX RTS, to establish a phased implementation schedule for FX clearing, depending on the category into which the parties to the FX falls. The categories of counterparty are the same as those proposed in the draft IRS RTS and the clearing obligation is proposed to take effect as follows:

  • Category 1 counterparties: 6 months after the FX RTS enter into force;
  • Category 2 counterparties: 12 months after the FX RTS enter into force;
  • Category 3 counterparties: 18 months after the FX RTS enter into force; and
  • Category 4 counterparties: 33 months after the FX RTS enter into force.

As with the draft IRS RTS, it is proposed that, where a contract is entered into between parties which do not fall within the same category of counterparties referred to below, the date from which the clearing obligation takes effect for that contract shall be the later of the two.

The obligation to frontload FX is, as in the draft IRS RTS, proposed to apply only to counterparties within Categories 1 to 3 and, again, to apply differently between counterparties within Categories 1 and 2 and those within Category 3.  It is proposed that frontloading will only apply to:

  • Category 1 and Category 2 counterparties’ contracts  entered  into  or  novated:
  • before the date of publication of the FX RTS in the Official Journal, if they have a minimum remaining maturity of 1 year and 6 months; and
  • after such date of publication, if they have a minimum remaining maturity of 3 months; and
  • Category 3 counterparties’ contracts, if they have a minimum remaining maturity of 2 years.

The consultation period runs until 6 November 2014.