In order to address one of the roots of the financial crisis, the G20 countries have committed to address risks related to the derivative markets. As far as the EU is concerned, the European Parliament and the Council have adopted a regulation that requires derivative transactions that are not executed on a regulated market (so-called OTC derivatives) to be cleared, and derivative contracts to be reported. It also sets a framework to enhance the safety of central counterparties and for trade repositories and further regulatory and implementing technical standards (European Market Infrastructure Regulation, “EMIR“).
EMIR was adopted on 4 July 2012 and entered into force on 16 August 2012. A first set of EMIR obligations have entered into force on 15 March 2013.
EMIR classifies counterparties to OTC derivatives as financial and non-financial counterparties (“FC” and “NFC”). Corporate entities transacting derivatives in the ordinary course of business could safely assume that they qualify as a NFC. Depending on the question whether a clearing threshold has been passed, NFCs are further subdivided in NFC+ and NFC-, each qualification implying its own set of obligations. The most extensive set of obligations is imposed on counterparties qualifying as a NFC+.
The September 2013 Implementing Measures
On 15 September 2013 further implementing measures of EMIR take effect. These measures contain certain risk mitigation techniques such as portfolio reconciliation, portfolio compression and dispute resolution applicable to both FC and NFC.
In order to ensure that counterparties to an OTC derivative contract operate on and assume the same terms of trade, FCs and NFCs transacting in non-centrally cleared OTC derivatives must enter into an agreement that addresses the key terms under which their portfolios shall be reconciled, before entering into the OTC derivative contract. The portfolio reconciliation has to cover the key trade terms that identify each particular OTC derivative contract and shall include at least the valuation attributed to each contract. The frequency of the required portfolio reconciliation depends on the qualification of the counterparty as either FC or NFC and on the volumes of OTC derivatives contracts outstanding.
Portfolio compression entails that the counterparties to an OTC derivative maintain the same risk position, but reduce the number of contracts. From 15 September 2013, both FCs and NFCs with 500 or more OTC derivative contracts outstanding with a counterparty which are not centrally cleared must have procedures in place to regularly, meaning at least twice a year, analyse the possibility to conduct a portfolio compression exercise. The counterparties must be able to provide a reasonable and valid explanation to the relevant competent authority for concluding that a portfolio compression exercise is not appropriate.
EMIR requires FCs and MFCs to agree on detailed procedures and processes regarding disputes when concluding OTC derivative contracts with each other. These procedures must include the identification, recording, and monitoring of disputes relating to the recognition or valuation of the contract and to the exchange of collateral between counterparties. The procedures shall at least record the length of time for which the dispute remains outstanding, the counterparty and the amount which is disputed. In addition, there has to be a specific process for disputes that are not resolved within five business days.
Lastly, FCs with a license from the Dutch Authority for the Financial Markets (Autoriteit Financiële Markten, “AFM”) have to send dispute reports on disputes outstanding for at least 15 business days to the AFM (email@example.com) and FCs with a license from the Dutch Central Bank (De Nederlandsche Bank, “DNB”) should send their dispute reports to DNB. This obligation applies to disputes that concern the contract valuation, the exchange of collateral for an amount or a value higher than EUR 15 million.
How to satisfy the September 2013 Implementing Measures?
A NFC may decide to enter into certain agreements with its counterparty on the basis of documentation prepared by that counterparty or by the International Swaps and Derivatives Association (“ISDA”). The documentation prepared by certain Dutch financial institutions are comparable but also contain certain differences. It is recommended to assess the differences in the various sets of documentation in order to select the most preferable set taking into account the specific circumstances of the relevant counterparties.
Further EMIR Implementations
EMIR is implemented step by step and imposes further obligations on involved parties over time. The following key deadlines have been announced so far:
Click here to view dates.