The text of the proposed amendments to the European Markets Infrastructure Regulation (EMIR Refit) was published in the Official Journal of the European Union on 28 May 2019 and – with the exception of certain provisions that are subject to a delay – will come into force 20 days after publication, i.e., on Monday, 17 June 2019.
While the aim of EMIR Refit is to simplify the current EMIR regime and “address disproportionate compliance costs, transparency issues and insufficient access to clearing for certain counterparties”, there are certain amendments that require consideration and, in some cases, immediate action.
In this alert, we discuss certain key provisions of EMIR Refit which commodities firms should take into account when preparing for it.
This alert focuses on the changes that will affect non-financial counterparties (NFCs). However, it is first worth noting two major developments in relation to financial counterparties (FCs). These changes will also indirectly affect NFCs, as their EMIR obligations will differ depending on the categorisation of their counterparty.
- Alternative investment funds (AIFs) – EMIR Refit expands the definition of FCs to capture all EU AIFs, with two minor exceptions (see our client alert entitled “EMIR amendments: Big changes for alternative investment funds”); and
- Small financial counterparties – EMIR Refit creates a new category of small FC for those FCs whose open OTC derivatives positions do not exceed the clearing thresholds, i.e., “small FCs” or “FC-” (this is a similar sub-categorisation to NFC+ and NFC- under the current EMIR regime).
- Although small FCs will still be subject to obligations to exchange margin, they will be exempt from the clearing obligation.
- An FC wishing to take advantage of this regime should run this calculation every 12 months, based on the aggregate month-end average position for the previous 12 months, and must notify ESMA and its competent authority if either: (i) it does not calculate its positions; or (ii) it exceeds any of the clearing thresholds.
- There is no delayed implementation of the clearing obligation, so FCs must be in a position to comply on the day EMIR Refit comes into force.
Non-financial counterparties – asset classes
One of the most well publicised changes under EMIR Refit is the new asset-class-specific approach to the clearing threshold. Currently, the clearing obligation operates on a ‘breach one, breach all’ basis. If an NFC (NFC Co) exceeds the clearing threshold for a single class of OTC derivatives contracts (let’s assume in commodity derivatives), it will become subject to the clearing obligation for that class and for all of the others even if its activities in relation to those asset classes are below the applicable clearing threshold. This means that NFCs exceeding the clearing threshold for commodity derivatives (no classes of which have been made subject to the clearing obligation) are required to clear OTC interest rate derivatives and other classes of derivative which are subject to the clearing obligation even where their activities in those classes are very limited.
Under EMIR Refit, this will no longer be the case. In our example, where NFC Co has calculated its OTC derivative positions in accordance with EMIR Refit (see below), it will only become subject to the clearing obligation in respect of classes of OTC derivative contracts for which it has exceeded the applicable clearing threshold. Therefore, NFCs that exceed the threshold for commodity derivatives only are not, as a result, subject to the clearing obligation for interest rate derivatives or other classes of derivative contracts.
However, the ‘breach one, breach all’ rule in respect of the exchange of collateral remains unchanged. This means that if an NFC exceeds the clearing threshold for any class of OTC derivatives, it would also remain subject to the requirement exchange collateral in respect of OTC derivative contracts in all other classes of OTC derivative contract.
Recital 8 of EMIR Refit summarises this neatly: “Those non-financial counterparties should be subject to the clearing obligation only with regard to the classes of OTC derivatives that exceed the clearing threshold. Non-financial counterparties should nonetheless remain subject to the requirement to exchange collateral where any of the clearing thresholds is exceeded.”
What should you do now?
Review your positions by class of OTC derivative contract and prepare to amend EMIR classifications as necessary.
Calculation of positions
Under article 10(1) of EMIR, all NFCs are required to determine whether their rolling average position over 30 working days exceeds a relevant clearing threshold.
Article 1(8)(a) of EMIR Refit (which replaces articles 10(1) and (2) with wholly new provisions) now asks NFCs to calculate their threshold position every 12 months on a month-end average basis.
The new article 10 imposes a new regime for threshold calculations. An NFC which either: (i) does not calculate its positions; or (ii) exceeds any of the clearing thresholds:
a. must immediately notify ESMA and its competent authority;
b. must establish clearing arrangements within four months of the above notification; and
c. becomes subject to the clearing obligation for the positions that were entered into or novated not less than four months after it made the above notification that:
i. pertains to those asset classes in respect of which the result of the calculation exceeds the clearing thresholds; or
ii. where the NFC has not calculated its position, pertains to any class of OTC derivatives subject to the clearing obligation.
It remains the case that an NFC calculating its positions is required to include all OTC derivatives entered into by the NFC and by other non-financial entities within the group to which the NFC belongs.
What does this mean?
ESMA confirmed in a public statement on 28 March 2019 that this new regime applies as soon as the EMIR Refit text enters into force.6 As a result, NFCs choosing to calculate their positions in the manner described above need to collect the necessary data and create systems to perform the calculation as soon as possible, so as to be ready for 17 June 2019, the EMIR Refit implementation date.
NFCs which have not run the threshold calculation are subject to an “immediate” requirement to notify their competent authority that they have not done so; and, as a result, become subject to applicable clearing requirements, as if they were over the threshold for all the asset classes.
In other words, an NFC- firm which does not run the calculation on 17 June 2019 (and cannot show that it has done so) may find itself over the clearing threshold for all classes. This could change its margining and risk mitigation obligations for some classes and, if it enters into certain interest-rate or credit derivatives, it may become subject to a clearing obligation for those within four weeks.
What should you do now?
If an entity wishes to ensure it is an NFC- for the relevant asset classes, then it would be prudent to make sure there is an audit trail showing it carried out the calculation on the day EMIR Refit comes into force. It should do the same every 12 months thereafter.
This audit trail might, for example, be served by ensuring the calculation is approved in board minutes of either the relevant NFC entity or a compliance committee, though this is by no means the only way. In strict terms, each NFC is required to notify ESMA and the relevant competent authority if it has not made the required calculation – and therefore an audit trail showing such delegation should be available in respect of each NFC.
New entity categorisations
Some of the changes under EMIR Refit will cause counterparties to not only establish new processes, but also update established ones. For example, the switch from the ‘breach one, breach all’ test to the asset-class-specific test will mean that many firms will need to revisit the processes by which they populate their reporting fields. For example, the answer to field 16, “clearing threshold”, is likely to change for many. The new calculation will have a similar impact.
In a similar vein, firms should check the representations and other statements they provide about their EMIR status in standard master trading documents, as these may be affected by the changes.
Although these amendments might appear simple, changes such as these often require a longer lead time than firms originally anticipate.
What should you do now?
Review your standard reporting fields and standard EMIR classification representations.
Reporting regime changes
Under the current EMIR regime, intra-group transactions are subject to the transaction reporting obligation. This is set to change under EMIR Refit, which recognises at recital 16 that “the obligation to report such transactions imposes significant costs and burden on non-financial counterparties”.
Consequently, the EMIR Refit text provides an exemption (see article 1(7)) from the transaction reporting obligation for derivatives between group companies where at least one is a non-financial counterparty, provided that:
a. both counterparties are included in the same consolidation on a full basis; b. both counterparties are subject to appropriate centralised risk evaluation, measurement and control procedures; and c. the parent is not a financial counterparty.
What should you do now?
Firms that wish to use this exemption must notify their competent authority of their intention (and the exemption will apply unless the competent authority responds within three months that it does not agree that the conditions have been met.)
Under EMIR Refit (see article 1(7)(b)), FCs will be “solely responsible and legally liable” for reporting contracts concluded with an NFC- on behalf of both parties. FCs are also responsible for ensuring the correctness of the details reported. Equally, an NFC- will not be required to report concluded contracts with a third country counterparty that would be an FC if established in the European Union provided that:
a. the third country reporting regime has been deemed equivalent; and b. the third country FC has reported the relevant trades.
The new rule does still require the NFC- to provide the FC with details of the contracts that it “cannot be reasonably expected to possess”. Responsibility for this information remains with the NFC-.
EMIR Refit recognises that many NFC- firms may have already invested in a reporting system to report details of contracts concluded with FCs to a trade repository. The text therefore gives NFC- firms the option to choose to continue reporting these contracts, and the NFC- firms should inform the FCs if they wish to do so.
What should you do now?
Article 2(b) of EMIR Refit provides that this provision shall apply 12 months after EMIR Refit enters into force (i.e., from 18 June 2020). NFC- firms that wish to continue reporting trades with FCs should inform the FCs far in advance of this date.