On 4 May 2017, the European Commission published a Draft Regulation (and related Annex) setting out its proposals to amend the European Market Infrastructure Regulation (EMIR).

The Commission had published its EMIR Report in November 2016, following a public consultation. In that Report, the Commission confirmed its view that the EMIR framework was functioning well, and that no fundamental changes were necessary. It did, however, signal that a limited number of targeted changes could be made to make EMIR's requirements more efficient and straightforward, and reduce the compliance burden and costs for smaller organisations. The draft Regulation sets out the proposed legislative changes in this regard.

KEY PROPOSED CHANGES:

Financial Counterparties (FCs): broader scope

It is proposed, with little in the way of explanation, that all alternative investment funds (AIFs) (as defined in the AIFMD) would be treated as FCs. Currently, only AIFs with an EU-registered/authorised alternative investment fund manager are treated as FCs, with the remainder treated as non-financial counterparties (NFCs). It is also proposed that securitisation special purpose entities (SSPEs) (within the meaning of the Capital Requirements Regulation) and central securities depositaries would be treated as FCs under EMIR.

Regarding SSPEs, no provision has been made in the draft Regulation for the grandfathering of existing deals. The impact on SSPEs (which are not currently subject to any clearing or margin obligations under EMIR) would be significant. While SSPEs may not have volumes of derivative contracts sufficient to bring them within the scope of the clearing obligation, they may become subject to margining requirements which would present difficulties for SSPEs who tend to only have limited free reserves. The effect on SSPEs who are not within the scope of the proposed Regulation on "simple, transparent and standardised" securitisations (the STS Regulation) is likely to be more significant than for those that are within the scope of that proposed Regulation, as the proposed STS Regulation purports to exempt in scope SSPEs from the clearing obligation.

Reporting

» FC and NFC-: To reduce the reporting burden for NFC-s, OTC transactions between an FC and an NFC- would be reported by the FC on behalf of both parties, and the FC would be responsible for the accuracy of the details that are reported.

» Intragroup: Intragroup OTC transactions where at least one counterparty is an NFC would no longer need to be reported, as they are viewed as posing little systemic risk.

» Exchange-traded derivatives (ETDs): ETDs would be reported by the central counterparty (CCP) only (on behalf of both parties) and the CCP would be responsible for the accuracy of the details that are reported.

» Clarifications: The draft Regulation clarifies that where an OTC derivative transaction is entered into by a UCITS, its management company is responsible for meeting the reporting obligation, and where an OTC derivative contract is entered into by an AIF, its manager is responsible for meeting the reporting obligation.

» Backloading: The reporting of historic transactions entered into before, and still outstanding on, 12 February 2014 would no longer be required, as error-free reporting was proving difficult to manage.

Clearing

» Aligning certain aspects of FC and NFC reporting: NFCs would only need to clear contracts that exceed the clearing thresholds (and hedging activities would continue not to be counted towards its clearing thresholds). Further, when an NFC exceeds the clearing threshold for an asset class, it would be subject to the clearing obligation only in respect of that asset class (on the basis that NFCs are often active in only one class of OTC derivative). By way of contrast, an FC would be subject to the clearing obligation in respect of all of its contracts once it exceeds the threshold in one asset class, and its hedging activities would continue to count towards its clearing threshold. Both FCs and NFCs would become subject to the clearing obligation if their aggregate month-end average positions for March, April and May exceed the clearing threshold. Those calculations should be performed annually.

» Small FCs: Clearing thresholds would be introduced for small FCs on the basis that central clearing is not economically viable for them in light of their low activity volumes. Those small FCs would still, however, be subject to margin requirements. The clearing thresholds would be 1 billion in gross notional value for credit and equity derivatives contracts, and 3 billion for interest rate, foreign exchange, commodity and other OTC derivative contracts. Once a small FC exceeds a clearing threshold in one asset class, the clearing obligation would be triggered for all of its asset classes.

» Pension Scheme Arrangements (PSAs): As a workable solution has not yet been developed to enable PSAs to participate in central clearing, the exemption for PSAs from central clearing would be extended by a further 3 years.

» Front-loading: The frontloading requirement (i.e. the requirement to clear certain OTC derivative contracts concluded before the clearing obligation takes effect) would be removed.

» Offerings: Institutions offering clearing services would be required to do so under fair, reasonable and nondiscriminatory commercial terms. The Commission would be empowered to adopt Level 2 measures to specify the conditions under which commercial terms would be considered to be "fair, reasonable and nondiscriminatory".

Suspension of Clearing

The Commission would be allowed to suspend, on a temporary basis for up to 12 months, a clearing obligation where:

» the class of OTC derivative is no longer suitable for central clearing;

» a CCP is expected to stop clearing a specific class of OTC derivatives, and a replacement CCP cannot be sourced quickly; or

» there is a serious threat to financial stability within the EU.

Trade Repositories (TRs)

» TRs would be obliged to put in place procedures to verify the completeness and accuracy of data reported to them, reconcile data with other TRs where the other counterparty reported to a different TR and ensure the orderly transfer of data to another TR on request by the customer.

» TRs would also be obliged to allow counterparties who delegate reporting to another entity to view the data reported to the TR on their behalf.

» It would be possible for a TR to submit a simplified application for an extension of registration if already registered under the Securities Financing Transactions Regulation.

» The procedure for accessing data held in third country TRs would be simplified for EU authorities. 

CCP Transparency

CCPs would be required to provide their members with tools to allow them to stimulate the amount of collateral requested to clear future trades.

Risk-Mitigation

The European Supervisory Authorities would be obliged to develop Level 2 measures setting out standards for risk-management procedures requiring the timely, accurate and appropriately segregated exchange of collateral.

Insolvency

The proposal clarifies that the assets and positions recorded in clients' accounts will not be treated as part of the insolvency estate of the CCP or clearing member.

NEXT STEPS

The Commission has sought industry feedback on the proposal, and the proposal is also being submitted to the European Parliament and the EU Council for their consideration. The shape of the proposal may very well change as this process develops. The changes are not expected to be formally adopted until at least 2018, and would come into effect between 6 and 18 months later.

NOTABLE RECENT DEVELOPMENTS

On 13 June 2017, the Commission also published a draft Regulation (and related Annex) in respect of the supervision of CCPs. Under this proposal:

» a new supervisory mechanism would be established to ensure more consistent supervision of CCPs;

» the process for recognising and supervising third-country CCPs that are of key systemic importance would be made more rigorous; and

» a two-tier system would be introduced for classifying thirdcountry CCPs. CCPs that are not systemically important (Tier 1 CCPs) would continue to operate within the existing EMIR framework. CCPs that are regarded as systemically important (Tier 2 CCPs) would be subject to stricter prudential requirements and requirements to provide information and access to ESMA.

One of the reasons given by the Commission for this particular proposal is the expected increase in risks to the EU's financial stability that could result from a hard Brexit, as a significant portion of eurodenominated derivative transactions are currently cleared via UK-based CCPs.

Regulation of CCPs

The fact that, on a hard Brexit, UK CCPs may be treated as third country CCPs under EMIR was also a reason given by the European Central Bank when it published its Recommendation (on 22 June 2017) asking that it be given the power to regulate CCPs and other clearing systems. That recommendation has been sent to the European Parliament and the EU Council, and the Commission is expected to issue an opinion on the recommendation in due course.