In this month’s email, we take a look at recent developments concerning the European Market Infrastructure Regulation ("EMIR").
EMIR – a brief recap
EMIR - the EU derivatives regulation which applies to all EU entities which have OTC derivatives, whether or not that entity is regulated - was originally introduced in August 2012. Implementing measures have been coming into force ever since.
The extent to which these measures apply depend on the type of entity concerned and/or how that entity uses derivatives.
The measures, which have a direct impact on EU companies which are not regulated financial entities, are now largely in force. As a consequence, the focus of regulators across Europe with respect to corporates is increasingly on compliance. For example, the Financial Conduct Authority ("FCA") in the UK recently set out its areas of focus for compliance with EMIR for 2015 - in summary it has now moved from allowing time for implementation to enforcing compliance.
1. Trade reporting - FCA to enforce
ince February 2014, EU parties to a derivatives transaction have been required to report certain details of that transaction to a trade repository (a licensed third party) the day after such transaction has been entered into, substantively amended or terminated early. Initial compliance with the reporting obligation was difficult, owing to its rushed introduction and lack of preparedness at the trade repositories. Matters have improved since, although teething troubles remain for some market participants.
The FCA has now made it clear that they will be focusing on compliance with the reporting obligation across the market, both with regard to the timing of reports, and their accuracy. Many corporates will have chosen to delegate the reporting obligation to bank counterparties. In this context, the FCA’s focus may well be on what delegation arrangements have been made, as well what systems have been put in place to check the accuracy of reports.
Where a corporate has internal hedging transactions between group entities, it is important to note that these must be reported as for external facing transactions and this is not usually an obligation which can be delegated to a third-party.
2. Proper categorisation using proper systems
For companies other than regulated financial entities, the basis of EMIR is a classification test. The classification test is conducted by reference to the “clearing threshold” - if the relevant entity’s group enters into OTC derivatives for non-hedging purposes where the aggregate notional amount of those transactions exceeds a prescribed level the relevant entity is known as an “NFC+”(non-financial counterparty above the threshold), and if not, as an “NFC-” (non-financial counterparty below the threshold). In order to understand how EMIR applies to it, an entity needs to understand if it is classified as an NFC+ or NFC-.
Whilst most corporates will use OTC derivatives mainly or exclusively for hedging purposes, and will therefore be categorised as NFC-, the FCA has made it clear that they still need to have systems in place to monitor whether this is the case and be able to demonstrate that they have considered the issue on a case-by-case basis (not simply by reference to internal policies).
The FCA has indicated that they will be making enquiries of corporates who are active users of OTC derivatives with regard to compliance with EMIR. For heavy users of derivatives, or entities which have recently entered into high-profile transactions involving derivatives, it is particularly important that they have taken steps to comply with EMIR given the increased possibility of FCA scrutiny. The ultimate sanction for breaches of EMIR is likely to be a fine.
These enforcement priorities are not limited to the UK - a number of regulators in other EU jurisdictions are likely to take a similar approach to EMIR this year.