The European Parliament adopted the European Market Infrastructure Regulation (EMIR) on 4 July 2012. ESMA has subsequently published draft Level 2 technical standards.
The Regulation introduces mandatory clearing of OTC derivatives via one or more central counterparties (clearing houses) which will be authorised to clear classes of derivatives by an EU regulatory authority. The obligation covers those classes of standardised derivatives which ESMA identify as subject to the clearing obligation or which the clearing houses themselves identify with the approval of their regulator. All types of derivatives are covered, other than physically settled forward foreign exchange transactions. Clearing houses will require daily mark to market collateralisation of all cleared derivatives.
The clearing obligation applies if the derivative transaction has been concluded between two “‘financial counterparties” or where one or both of the parties is a non-financial counterparty for whom the 30-day rolling average of its positions exceeds a threshold set by ESMA. “Financial counterparties” include, inter alia, UCITS funds and EU and non-EU AIFs under the Alternative Investment Fund Managers Directive.
The Regulation also provides that financial counterparties, and non-financial counterparties exceeding the applicable clearing threshold, which enter into uncleared trades, must have appropriate measures in place to monitor, minimise and mitigate credit risk and operational risk. Whether this amounts to an obligation to post collateral for uncleared trades is unclear and ISDA have sought clarification from the Commission in this regard.
The Regulation also introduces mandatory reporting of all derivative trades to authorised trade repositories.
Timing and recommended actions: The clearing obligation will not apply until regulatory authorities authorise clearing houses, which is unlikely to be prior to July 2013. The reporting obligation applies on 1 July 2013 for interest rate and credit derivatives. Firms will need to consider the new documentation suite which will be put in place with brokers which will act as their “clearing member” in relation to each clearing house. ISDA and the UK Futures and Options Association (FOA) are currently working on an addendum to the ISDA Master Agreement or FOA standard futures terms which will govern the clearing relationship across all clearing houses.
EMIR’s impact will be significant, particularly in terms of: (i) the cost of posting margin; (ii) changes to booking systems and processes; and (iii) the clearing documentation required with each clearing member.
Following finalisation of the ISDA/FOA addendum, Dechert will issue a detailed client guide to EMIR.