The purpose of this memorandum is to summarise the main requirements derived from the European Market Infrastructure Regulation, or EMIR,1 which collective investment schemes established and licensed in Malta (including Professional Investor Funds, Alternative Investor Funds and UCITS) ("Maltese Funds") need to comply with.2

EMIR purports to lay down clearing and bilateral risk-management requirements for over-the-counter ("OTC") derivative contracts, reporting requirements for derivative contracts, and uniform requirements for the performance of activities of central counterparties ("CCPs") and trade repositories ("TRs").3 EMIR came into effect on 16th August 2012, and, as an EU Regulation, it is directly applicable in the EU Member States, including Malta, and does not require transposition into national law.

A Maltese Fund is considered to be a financial counterparty ("FC")4 if it is a UCITS or if it is a self-managed AIF or has appointed an external investment manager which is registered or authorised as an AIFM under the AIFMD5; otherwise, the MalteseFund qualifies as a non-financial counterparty ("NFC")6 for the purposes of EMIR.7 If the Maltese Fund is an NFC, it needs to be determine whether or not it exceeds (or is expected to exceed) the "clearing threshold"; the clearing threshold values for the purpose of the clearing obligation are:

  1. EUR 1 billion in gross notional value for OTC credit derivative contracts;
  2. EUR 1 billion in gross notional value for OTC equity derivative contracts;
  3. EUR 3 billion in gross notional value for OTC interest rate derivative contracts;
  4. EUR 3 billion in gross notional value for OTC foreign exchange derivative contracts;
  5. EUR 3 billion in gross notional value for OTC commodity derivative contracts and other OTC derivative contracts not provided for under points (a) to (d).8

Where an NFC takes positions in OTC derivative contracts and those positions exceed the clearing threshold mentioned above, that NFC shall:

  1. immediately notify ESMA and (in the case of a Maltese Fund) the MFSA;
  2. become subject to the clearing obligation for future contracts if the rolling average position over thirty working days exceeds the threshold; and
  3. clear all relevant future contracts within four months of becoming subject to the clearing obligation.9

The term "derivative" or "derivative contract" used in EMIR refers to the financial instruments listed in points (4) to (10) of MiFID10, namely:

  • options, futures, swaps, forward rate agreements and any other derivative contracts relating to securities, currencies, interest rates or yields, or other derivatives instruments, financial indices or financial measures which may be settled physically or in cash;
  • options, futures, swaps, forward rate agreements and any other derivative contracts relating to commodities that must be settled in cash or may be settled in cash at the option of one of the parties (otherwise than by reason of a default or other termination event);
  • options, futures, swaps, and any other derivative contract relating to commodities that can be physically settled provided that they are traded on a regulated market and/or an MTF;
  • options, futures, swaps, forwards and any other derivative contracts relating to commodities, that can be physically settled not otherwise mentioned in the previous indent and not being for commercial purposes, which have the characteristics of other derivative financial instruments, having regard to whether, inter alia, they are cleared and settled through recognised clearing houses or are subject to regular margin calls;
  • derivative instruments for the transfer of credit risk;
  • financial contracts for differences;
  • options, futures, swaps, forward rate agreements and any other derivative contracts relating to climatic variables, freight rates, emission allowances or inflation rates or other official economic statistics that must be settled in cash or may be settled in cash at the option of one of the parties (otherwise than by reason of a default or other termination event), as well as any other derivative contracts relating to assets, rights, obligations, indices and measures not otherwise mentioned above, which have the characteristics of other derivative financial instruments, having regard to whether, inter alia, they are traded on a regulated market or an MTF, are cleared and settled through recognised clearing houses or are subject to regular margin calls.

A chart summarising the timing of various obligations under EMIR and other information on the implementation of EMIR is available from the website of the European Securities and Markets Authority ("ESMA"). The Malta Financial Services Authority ("MFSA") is the designated competent authority in Malta for the purposes of implementing the relevant provisions of EMIR; the MFSA has issued a number of circulars regarding EMIR, which are available from the MFSA's website.

Failure to comply with the relevant provisions of EMIR may be sanctioned by an administrative penalty imposed by the MFSA in accordance with the Financial Markets Act (OTC Derivatives, Central Counterparties and Trade Repositories) Regulations (Legal Notice 81 of 2013).

REPORTING OBLIGATION

All Maltese Funds are required to ensure that the details of any derivative contract (i.e. exchange traded and OTC derivatives) they have concluded, and of any modification or termination of the contract, are reported to a trade repository registered or recognised under EMIR (or where a trade repository is not available, to ESMA). The details must be reported no later than the working day following the conclusion, modification or termination of the contract.

The reporting obligation applies to derivative contracts which:

  1. were entered into before 16th August 2012 and remained outstanding on that date;
  2. are entered into on or after 16th August 2012 (backloading).

The reporting of the details of the derivative contract may be delegated. The Maltese Fund is however required to ensure that the details of its derivative contracts are reported without duplication.11

Maltese Funds will need to obtain a Legal Entity Identifier ("LEI"), to be able to perform the reporting obligation. LEI codes can be obtained from endorsed entities forming part of the Global LEI Foundation.

The reporting obligation under the EMIR will commence on the 12th February 2014.

Furthermore, Maltese Funds must keep a record of any derivative contract they have concluded and any modification for at least five (5) years following the termination of the contract.12 This record keeping requirement entered into force on 16th August 2012.

CLEARING OBLIGATION

EMIR requires Maltese Funds which are treated as FCs or NFCs exceeding the clearing threshold ("NFC+"), to clear all OTC derivative contracts13 pertaining to a class of OTC derivatives14 that has been declared subject to the clearing obligation, if those contracts fulfil both of the following conditions:

  1. they have been concluded in one of the following ways:

    1. between two FCs;
    2. between an FC and an NFC+;
    3. between two NFC+; or
    4. between an FC or an NFC+, and an entity established in a third country that would be subject to the clearing obligation if it were established in the EU; and
  2. they are entered into or novated either:

    1. on or after the date from which the clearing obligation takes effect; or
    2. on or after notification to ESMA of the authorisation of a CCP to clear a certain class of OTC derivatives by a competent authority, but before the date from which the clearing obligation takes effect if the contracts have a remaining maturity higher than the minimum remaining maturity determined by the relevant Regulatory Technical Standards ("RTS").15

The clearing obligation applies only to certain classes of OTC derivatives: such classes are yet to be established, and will be identified in a public register available on ESMA's website. The actual date(s) of application of the clearing obligation will depend on the date of entry into force of the relevant RTS, which are still to be adopted under EMIR: currently, this is not expected to happen before June 2014.

OTC derivative contracts that are subject to the clearing obligation must be cleared in a CCP, which is authorised or recognised under EMIR to clear the relevant class of OTC derivatives and listed in a public register to be kept by ESMA. For that purpose, a Maltese Fund which is subject to the clearing obligation will need to either become a client of a clearing member (i.e. an undertaking which participates in the CCP and which is responsible for discharging the financial obligations arising from that participation), or establish indirect clearing arrangements with a clearing member.16

RISK MITIGATION TECHNIQUES

Maltese Funds that enter into OTC derivative contracts not cleared by a CCP, must ensure that appropriate procedures and arrangements are in place to measure, monitor and mitigate operational risk and counterparty credit risk, including at least:

  1. the timely confirmation, where available, by electronic means, of the terms of the relevant OTC derivative contract;
  2. formalised processes which are robust, resilient and auditable in order to reconcile portfolios, to manage the associated risk and to identify disputes between parties early and resolve them, and to monitor the value of outstanding contracts.17

The relevant RTS18 set out specific rules related to the risk mitigation techniques to be applied under EMIR, in particular the following:

  1. Timely confirmation: confirmation of the conclusion of OTC derivatives must be made in accordance with the time frames established by the RTS;
  2. Portfolio reconciliation: portfolio reconciliation by the counterparties to the OTC derivative contracts or by a qualified third party mandated to this effect by the counterparty must be performed in accordance with arrangements to be agreed between the counterparties and the manner and frequency prescribed by the RTS;
  3. Portfolio compression: the possibility to conduct a portfolio compression exercise is to be analysed regularly and at least twice a year, where five hundred (500) or more OTC derivative contracts are outstanding with a counterparty;
  4. Dispute resolution: detailed procedures are to be agreed upon with counterparties for the identification, recording, monitoring, and resolution of disputes, and outstanding disputes must be reported to the competent authority, in accordance with the RTS.

The above mentioned requirements regarding risk mitigation techniques started to apply from the coming into force of the relevant RTS, namely: 15th March 2013 for timely confirmations; and 15th September 2013 for portfolio reconciliation, dispute resolution, and portfolio compression.

The value of outstanding contracts of FCs and NFC+ must be marked-to market on a daily basis; where market conditions prevent marking-to-market, reliable and prudent marking-to-model must be used.19

Maltese Funds that are FCs or NFC+ are also required to have risk-management procedures that require the timely, accurate and appropriately segregated exchange of collateral with respect to OTC derivative contracts that are entered into on or after 16th August 2012, for FCs, or on or after the clearing threshold is exceeded, for NFC+.20 These rules took effect from 16th August 2012.

Furthermore, Maltese Funds that are FCs must hold an appropriate and proportionate amount of capital to manage the risk not covered by appropriate exchange of collateral.21

Last updated: November 2013

Footnotes

1 Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories

2 For the purpose of this memorandum, we are relying on the assumption that the Maltese Fund is established in the form of an investment company with variable share capital (SICAV) under the Companies Act (Chapter 386 of the Laws of Malta).

3 Article 1(1) EMIR

4 The definition of "financial counterparty" comprises: investment firms authorised in accordance with Directive 2004/39/EC, credit institutions authorised in accordance with Directive 2006/48/EC, insurance undertakings authorised in accordance with Directive 73/239/EEC, assurances undertaking authorised in accordance with Directive 2002/83/EC, reinsurance undertakings authorised in accordance with Directive 2005/68/EC, UCITS and, where relevant, their management companies, authorised in accordance with Directive 2009/65/EC, institutions for occupational retirement provision within the meaning of Article 6(a) of Directive 2003/41/EC, and alternative investment funds managed by AIFMs authorised or registered in accordance with Directive 2011/61/EU.

5 Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers

6 Non-financial counterparties are undertakings established in the EU other than CCPs and FCs.

7 Article 1(2) EMIR states that: "This Regulation shall apply to CCPs and their clearing members, to financial counterparties and to trade repositories. It shall apply to non-financial counterparties and trading venues where so provided."

8 Article 11 of Commission Delegated Regulation (EU) No 149/2013 of 19 December 2012 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on indirect clearing arrangements, the clearing obligation, the public register, access to a trading venue, non-financial counterparties, and risk mitigation techniques for OTC derivatives contracts not cleared by a CCP

9 Article 10(1) EMIR

10 Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets in financial instruments

11 Article 9(1) and (3) EMIR

12 Article 9(2) EMIR

13 The term "OTC derivative" or "OTC derivative contract" means a derivative contract the execution of which does not take place on a regulated market as within the meaning of Article 4(1)(14) of Directive 2004/39/EC or on a third- country market considered as equivalent to a regulated market in accordance with Article 19(6) of Directive 2004/39/EC.

14 The term "class of derivatives" means a subset of derivatives sharing common and essential characteristics including at least the relationship with the underlying asset, the type of underlying asset, and currency of notional amount. Derivatives belonging to the same class may have different maturities.

15 Article 4(1) EMIR

16 Article 4(3) EMIR

17 Article 11(1) EMIR

18 Commission Delegated Regulation (EU) No 149/2013 of 19 December 2012 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on indirect clearing arrangements, the clearing obligation, the public register, access to a trading venue, non-financial counterparties, and risk mitigation techniques for OTC derivatives contracts not cleared by a CCP

19 Article 11(2) EMIR

20 Article 11(3) EMIR

21 Article 11(4) EMIR

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.