EMIR Gets Much Needed Makeover

The European Parliament’s recent vote on EMIR suggests that proposals to ease the burden of reporting will finally come to fruition this year.

Proposals to simplify the regulations governing over-the-counter (OTC) derivatives appear to be gathering pace after the European Parliament voted in favor of an amendment to the European Markets Infrastructure Regulation (EMIR). As we’ve discussed, 2018 has been a year of regulatory recalibration rather than new rule generation. Global policymakers are exercised with updating existing rules to ensure they are fit for purpose and operating as intended. Continued refinement and amendments to EMIR are another example of this recurring theme. As EMIR gets a makeover, let’s take a closer look at some of the wrinkles regulators are ironing out.

In a plenary session on June 12, the European Parliament gave their overwhelming support to measures that will simplify clearing rules for small and non-financial counterparties, introduce distinct clearing thresholds, and exempt pension scheme arrangements from current clearing obligations. The proposed amendments form part of the European Commission’s Regulatory Fitness and Performance (REFIT) program. REFIT aims to ensure regulations achieve their stated objective while being mindful of the regulatory and administrative burden placed on in-scope market participants. The amendments place focus on the types of financial counterparty and the specific risks that each requirement poses with adjustments made accordingly.

Although the outcome is dependent upon upcoming negotiations between the EU Parliament, Council, and Commission (the Trilogue), there are components that asset managers and banks currently within the scope of EMIR should revisit current EMIR implementation and start to map current processes against the most recent iteration of the amendments adopted by the European Parliament.

Exchange of Variation Margin

As discussed before, the European Supervisory Authorities proposed much welcome change with respect to the scope and impact of physical forwards variation margin. Whilst the prior expectation was that clarity would be provided in Q1 2018, further consideration of the text has led to the current proposal that such exemptive relief should be widened to encompass physically settled foreign exchange swaps also.

The obligation to exchange variation margin will continue to be applicable to transactions between systemically important counterparties, but as another step towards global regulatory convergence, this is a welcome development to the industry.

Clearing

The amendment aims to ease the burden on small financial counterparties by releasing them from clearing obligations when the volume of OTC derivatives they deal with is both too low to present a systemic risk and for central clearing to be “economically viable.” Non-financial counterparties (NFCs) will only be subject to clearing obligations once they exceed the clearing threshold; and they must only clear those asset classes for which they have breached the threshold. To prepare for the changes, counterparties may wish to carefully consider the volume of derivatives they deal with to see if they can avail of the new exemptions.

Reporting

The amendment makes several changes to counterparties’ reporting obligations:

  • UCITS management companies and Alternative Investment Fund (AIF) managers will be responsible for reporting on behalf of the UCITS or AIF and for the accuracy of such reporting.
  • A financial counterparty trading with a small NFC should take responsibility for reporting a single set of data on behalf of both parties. The amendments include the flexibility for an NFC to report for itself, should it wish to do so. This choice would need to be conveyed to the financial counterparty.
  • The requirement to report historical trades is likely to disappear. Only derivative contracts entered into on or after the application of the reporting requirement (February 12, 2014) will need to be reported.
  • All transactions between affiliates within a group including at least one NFC should be exempt from reporting although the final rules will need to specify any conditions with respect to the place of establishment of the NFC.

Most of these changes will reduce the reporting burden. However, institutions will feel the impact of EMIR more widely because UCITS and AIFs fall into the definition of a financial counterparty regardless of where they are situated. Fund managers will need to carefully consider whether they have the infrastructure in place to comply with the new reporting requirements.

Pension Schemes

Pension scheme arrangements are not currently subject to central clearing because CCPs do not enable the transfer of non-cash collateral. The current amendments propose that this exemption is extended two more years (three years for small schemes), and empowers the European Commission to extend this another year (two years for small schemes). However, on July 3, the European Securities and Markets Authority (ESMA) issued a statement clarifying that they do not have the legal remit to extend the current temporary exemption until the EMIR amendments have been finalized. However, ESMA emphasized that to the extent that an exemption is likely to become permanent, it does not expect NCAs to give priority to effecting supervisory action against entities entitled to the exemption. This will be another case of the NCAs applying their risk based powers proportionally.

What’s Next?

In its first reading, it’s evident the European Parliament integrated responses from various participant consultations in the amendments. It is positive that regulators are open to hearing pragmatic suggestions of improvement from the market. In particular, the consideration of the scope of the mandatory exchange of variation margin shows deep consideration and recognition of the global nature of the derivatives market and the impact that divergent rules may have.

Later this month, the Trilogue will begin with a view to finalize the amendments proposed in the first reading by Parliament by the end of 2018. Although things can still change, it looks as though regulators paid attention to the challenges the industry faces and that EMIR II will bring some welcome clarity by the end of the year.