Principally those entities subject to EMIR – Financial Counterparties ("FCs") and Non-Financial Counterparties ("NFCs"). However, “third country” entities incorporated outside the EU may also be affected, both directly as a result of changes to the definition of “FC” and indirectly, when trading with EU FCs and NFC+s.
First tabled in May 2017, the EMIR Refit changes have been the subject of much interest. This alert focuses on the key items for funds and asset managers.
1. Financial CounterpartiesChange to the definition of FC
Currently: AIFs are only included within the definition of FC if they are managed by an authorised or registered AIFM.
Revised: All EU AIFs, irrespective of their manager’s status are classified as FCs.
2. The Clearing Obligation
Currently: All FCs are subject to the clearing obligation.
- FCs whose derivatives are below the clearing thresholds are exempt from the EMIR clearing obligation, creating a new category of so called "Small FCs." The thresholds are the same as those currently applying to NFCs. When adding up total derivatives, FCs must include all OTC derivatives across their group, whether risk reducing or not. Small FCs remain subject to the EMIR OTC margin requirements.
- If a Small FC subsequently crosses any of the thresholds, it will become subject to the clearing obligation for all relevant derivatives. The FC must notify ESMA and its relevant national competent authority (“NCA” – i.e. the FCA, AMF etc) and clear the relevant OTC derivatives within four months. Similarly, an FC that subsequently falls below the clearing thresholds will no longer be subject to the clearing obligation but must first notify its NCA and evidence the change in status.
Currently: NFCs become subject to the clearing obligation when their derivatives activity (risk reducing trades excluded but calculated across all group NFCs) crosses the clearing threshold of any asset class.
Revised: NFCs must only clear those derivatives in the asset classes where the clearing threshold has been exceeded. In contrast to the new FC calculation, NFCs still exclude risk reducing trades.
- In its related March guidance, ESMA confirmed that it will be at the discretion of FCs and NFCs to decide whether to conduct the calculation to determine whether their OTC derivatives trades exceed the clearing threshold. If the decision is taken not to calculate, ESMA and the relevant NCA must be notified and the clearing obligation will automatically apply. The first calculation is due on the day the EMIR Refit goes live and captures average monthly derivatives activity in the last 12 months. The calculation must then be repeated annually.
- In that same statement, ESMA clarified that it expects all existing FCs and NFCs taking positions in OTC derivatives that exceed the relevant thresholds to notify ESMA and the relevant NCA, whether they were previously subject to the clearing obligation or not. These notifications must be made on the day that the EMIR Refit enters into force. All entities should therefore be making the relevant preparations and calculations now. Regulators across the EU have started making updates to EMIR related sections of their websites to facilitate such notifications.
Addressing concerns about access to clearing, the EMIR Refit introduces an obligation to provide clearing services on terms which are fair, reasonable, non-discriminatory and transparent. Further delegated legislation is expected which specifies the conditions under which commercial terms satisfy these requirements.
Changes to reporting responsibility. The EMIR Refit amends the parties responsible (and legally liable) for trade reporting. These changes are implemented with a 12-month delay. From such date:
- Where FCs and NFCs below the clearing threshold (i.e. “NFC-s”) transact, the FC is responsible for reporting on behalf of both counterparties. The NFC- is free to inform its FC counterparties that it has decided to report on its own behalf, in which case the NFC- will remain responsible for the reports.
- For UCITS, its UCITS Management Company is responsible for reporting.
- For AIFs, the AIFM is responsible for reporting.
Backloading; intra-group transactions. The EMIR Refit removes the existing reporting backloading requirement. Similarly, as intra-group transactions between NFCs represent a relatively small proportion of OTC derivatives, the EMIR Refit removes the reporting requirement for group transactions where an NFC (or a third country FC) is a counterparty. Counterparties must notify the relevant NCA of their intention to use this exemption.
Further changes – reporting still under the spotlight. Although the major changes to the EMIR reporting obligation called for by some are not included in the EMIR Refit, there is a focus in the text on improving reporting standards and “effectiveness and efficiency” is a strong theme. Within 12 months there will be further legislation relating to the reporting standards, with a view to harmonising requirements under other key EU legislation that also impose reporting requirements on entities i.e. SFTR and MiFIR. The EMIR Refit also increases the upper limit applying to fines for trade repositories. Combined with the recent regulatory focus on reporting and large fines for non-compliant counterparties, the EMIR Refit emphasis on reporting standards suggests that the enforcement of the reporting obligation will continue to be high on the agenda for NCAs.
4. Third Country Managers and Funds
As has been the case since EMIR took effect, EU dealers must consider the EMIR status of all counterparties, and for third country entities, consider which EMIR category a third country entity would be if it were incorporated into the EU. If that entity comprises a so-called “third country” FC or NFC+, certain EMIR requirements will apply; principally the clearing and margin requirements.
Changes to the definition of FC mean that entities categorised by EU dealers as non-EU AIFs will indirectly become subject to these EMIR requirements. The derivatives market is alive to the fact that this could trigger a big change for some third country entities and on a very short time frame. ISDA has recently published a note on AIFs and the EMIR Refit changes and there are calls for a period of regulatory forebearance for entities that now find themselves in-scope or re-categorised.
- Consider your EMIR status. Consider if and how your EMIR categorisation may be affected by the changes. Are you ready to make the new calculations? Are any notifications required? Do any EMIR related documents or representations require updating?
- Brexit – I am a UK counterparty. Will I still be subject to the changes? Put simply, yes, we expect so, including those that do not take effect immediately.