Although EMIR came into force as long ago as August 2012, the clearing obligation it provides for was first brought into effect in December 2015 on a phased basis and only for certain interest rate swaps denominated in the G4 currencies.
Under the European Market Infrastructure Regulation (EMIR), over-the-counter (OTC) derivatives contracts entered into or novated from the date that the clearing obligation (CO) takes effect (or during the frontloading period, if applicable) must be cleared by an authorised central counterparty (CCP) for European CCPs or a recognised third-country CCP.
The CO applies to contracts between any combination of financial counterparties (FCs) and above threshold nonfinancial counterparties (NFC+), where
- at least one counterparty is in the EU or
- neither counterparty is in the EU, albeit in very limited circumstances.
The CO will only bite on a derivative contract that falls within a class of derivatives that the European Commission has declared is subject to the CO. The inaugural class of derivatives subject to the CO are interest rate swaps (IRS) denominated in the G4 currencies (EUR, GBP, JPY, and USD): more precisely, fixed-to-float IRS and float-to-float swaps in any of those currencies and forward-rate agreements and overnight index swaps in EUR, GBP, and USD. The legal source of this development is the Commission Delegated Regulation of 6 August 2015 (the Delegated Regulation), which was published in the Official Journal on 1 December 2015 and took effect on 21 December. After the start date, the CO is helpfully phased in over three years to allow additional time for smaller participants to begin complying. Accordingly, the first clearing requirements will begin on 21 June 2016. The start date is complicated by frontloading requirements for certain counterparties (discussed further below). The remainder of this LawFlash addresses the CO as it applies in respect of IRS specified by the Delegated Regulation.
There are significant exemptions from the CO for
- contracts concluded with covered bond issuers or cover pools for covered bonds, provided that they meet certain conditions;
- certain intragroup transactions; and
- specified pension arrangements until 16 August 2017.
Where the European Commission declares a third country’s derivatives regime equivalent to EMIR, counterparties to a trade involving a counterparty based in that third country can instead rely on compliance with the third country’s regime (see Article 13 of EMIR). Even where the regime-equivalence exemption does not apply, CCP equivalence should still enable use of third-country CCPs recognised by the European Securities and Markets Authority (ESMA) for meeting the clearing obligation (Article 25 of EMIR). To date, ESMA has recognised a wide range of third-country CCPs but has not yet recognised any US CCPs.
The Point at Which the CO Applies; Frontloading
Under EMIR, the CO applies to contracts entered into after the clearing requirement for a specified class of derivatives takes effect. Moreover, as a result of an approach under EMIR known colloquially as “frontloading”, the CO will also apply earlier than the above point where an EU national regulator has notified ESMA that it has authorised a new CCP to clear specified classes of derivatives (as it must do under EMIR). Following such a notification, ESMA will recommend to the European Commission whether any new classes of derivatives that will be cleared by the CCP should be subject to the CO. Frontloading means that if the European Commission ultimately decides that the CO should apply, contracts in those derivatives that were entered into or novated on or after the date of such a notification to ESMA and before such European Commission decision (typically, a lengthy period of time) will be subject to the CO.
Consequently, counterparties negotiating a contract that relates to a class of derivative not yet subject to the CO, but in respect of which an EU national regulator has made a CCP notification to ESMA, would need to proceed on the basis of the following two different fact patterns:
- The contract may be subject to the contract clearing requirements
- The CO will not apply, and instead, the contract will be subject to the risk mitigation requirements of EMIR
The frontloading requirement is mitigated by its application only to contracts with a remaining maturity that exceeds thresholds specified by the European Commission.
There is concern that third-country entities may reduce their trading volumes with European counterparties to avoid the frontloading requirement. This would facilitate further undesirable fragmentation of the global OTC derivatives markets.
In preparing the Delegated Regulation, the European Commission concluded that different counterparties need different periods of time to put in place the necessary arrangements to clear the IRS subject to the CO. Accordingly, the Delegated Regulation classifies counterparties into four categories in which similar counterparties become subject to the CO from the same date. The two tables below usefully depict and explain how the CO will be phased in and when frontloading will begin by reference to relevant categories of counterparty (regarding IRS subject to the CO).
Scope of Each Category of Counterparty and Phasing Periods
Click here to view table.
Frontloading and CO Start Dates By Counterparty Category
Click here to view table.
Note: where a contract is concluded between two counterparties included in different categories, the date from which the CO takes effect for that contract will be the later date.
Next Classes of Derivatives Waiting in Line for CO to Be Applied
In November 2015, ESMA recommended to the European Commission that fixed-to-float IRS and forward-rate agreements denominated in NOK, PLN, and SEK next be made subject to the CO.
For further information about EMIR, read our previous LawFlashes:
- Implementing Measures of European Market Infrastructure Regulation Take Effect
- Obligations Under European Market Infrastructure Regulation Imminent
- Update on the European Market Infrastructure Regulation
- ESMA Calls for a Uniform Definition of “Derivatives” Under EMIR