The European derivatives regulatory reforms originally adopted in the summer of 2012 and commonly referred to as EMIR are close to full implementation with the entry into force this past spring of technical standards published by the European Securities and Markets Authority (“ESMA”).
EMIR enables the EU to deliver on the 2009 commitments regarding over-the-counter (“OTC”) derivatives agreed to by the G20 countries that all standardized OTC derivatives be (i) reported to registered trade repositories in an effort to increase market transparency and (ii) cleared with central counterparties (clearinghouses) in order to reduce counterparty credit and operational risks.
This article provides an overview of the main obligations imposed by the regulations on buy-side market participants. In this Part 1 we discuss the scope and application of EMIR and address trade reporting and recordkeeping. Part 2 will focus on clearing and risk mitigation requirements for non- cleared derivatives and EMIR’s cross-border application.
Scope and Application of EMIR
Products covered by EMIR. EMIR applies to all derivatives contracts identified in the Market in Financial Instruments Directive and not executed on a regulated market, which is broadly defined to include most options, swaps, forwards and any other derivatives contracts relating to commodities (to the extent cash-settled), securities, currencies, interest rates or indices.
Foreign exchange derivatives contracts (i.e., FX swaps and forwards, exclusive of spot trades) are also within the scope of EMIR, though ESMA still needs to provide guidance as to whether FX derivatives will be subject to the clearing obligation.
Market participants covered by EMIR — Territorial Application. EMIR applies to financial and non-financial counterparties organized in the European Economic Area (“European Area”) and to entities established outside the European Area (“Non-European Entities”) that would be subject to certain requirements under EMIR if they were established in the European Area.
Financial counterparties include investment firms, banks, insurance companies, registered (UCITS) funds, pension funds and alternative investment funds (such as hedge funds and private equity funds) managed by an alternative fund manager authorized or registered under applicable European regulations. Non-financial counterparties are entities established in the European Area that are not financial counterparties and, within this category, EMIR differentiates entities based on whether they are above or below a specified clearing threshold.
Reporting and Recordkeeping Obligations
EMIR requires all counterparties and clearinghouses to ensure that the details of any derivatives contract subject to the regulations (including non-cleared and intra-group derivatives) are reported to a registered trade repository.
Who reports? Unlike Dodd-Frank, where reporting obligations will mainly be satisfied by execution platforms, clearinghouses or by only one of the counterparties to a trade (primarily registered swap dealers), EMIR imposes reporting obligations on all counterparties and clearinghouses.
In order to avoid reporting inconsistencies, EMIR requires that derivatives contracts are reported without duplication and permits counterparties to delegate the reporting obligation to one of them, a third party or, in the case of cleared derivatives, the clearinghouse. Nonetheless, despite any such delegation, both counterparties remain legally responsible for ensuring that the details of their derivatives contracts are properly reported.
Pursuant to ESMA’s cross-border proposals, (i) EMIR reporting requirements will not apply to a transaction between a European Area entity and a Non-European Entity if the Non-European Entity is located in a third country for which ESMA has determined there are equivalent reporting requirements and (ii) even if a transaction between two Non-European Entities has a direct, substantial and foreseeable effect within the EU, the Non-European Entities will not be required to comply with EMIR reporting requirements. Clarification and further guidance with respect to the reporting requirements is expected from ESMA.
What must be reported and when? ESMA’s technical standards set out the minimum details of data required to be reported to the trade repositories within one working day after derivatives contracts have been concluded, modified or terminated. This includes details regarding the parties to the derivative contract (Legal Entity Identifier, name, domicile, corporate sector) and the main characteristics of the derivatives contract (such as type, underlying asset/metric, maturity, notional value, price, or collateral terms). A main characteristic of the derivatives contract also includes the venue of execution since the reporting obligation extends to both exchange-traded and OTC derivatives contracts.
Backloading — Historical Swaps. Pursuant to EMIR, all derivatives contracts entered into (i) before August 16, 2012 and that were outstanding on that date and (ii) on or after August 16, 2012, will have to be reported to a registered trade repository. Those derivatives contracts that were entered into before August 16, 2012 and are outstanding when reporting obligations begin, must be reported to a trade repository within 90 days of the reporting start date for a particular asset class. Derivatives contracts that were in existence on August 16, 2012, or were entered into on or after that date, but are not outstanding on or after the reporting start date for a particular asset class, must be reported to a trade repository within 3 years of the reporting start date for such asset class.
Timing and Implementation Date. ESMA recently announced that reporting for all five asset classes —interest rate, credit, foreign exchange, commodities and equity — is expected to commence on January 1, 2014. Additionally, ESMA has proposed to distinguish between whether a derivative is exchange-traded or OTC and only require reporting for exchange-traded derivatives beginning January 1, 2015. Although ESMA has indicated the urgency of this matter, the European Commission has 3 months to decide whether to endorse ESMA’s recommendation.
Public Dissemination. Trade repositories are required, on a weekly basis, to publish and update certain derivatives contract data reported to them. Such data is required to be made available on a website or an online portal easily accessible by the public and include at least a breakdown, by derivatives class, of aggregate open positions, transaction volumes and values.
Confidentiality obligations. In circumstances where a counterparty or clearinghouse has delegated its reporting obligation to a third party, EMIR provides that the reporting of derivatives contracts in accordance with the regulations will not give rise to a breach of any applicable contractual non-disclosure obligations. Additionally, the ISDA EMIR Portfolio Reconciliation, Dispute Resolution and Disclosure Protocol (the “Protocol”) includes a confidentiality waiver to help ensure that market participants can comply with their regulatory requirements under EMIR without breaching any confidentiality restrictions that they may be subject to. Specifically, by adhering to the Protocol, market participants will consent to the disclosure of information or the retention of information in accordance with EMIR and related regulations.
Recordkeeping Obligations. EMIR requires counterparties to keep a record of any derivative contract they have concluded and any modification to such contract for at least 5 years following the termination of the contract.