On April 14th 2014 the European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA) and the European Securities and Markets Authority (ESMA) issued a consultation paper on draft regulatory technical standards (Consultation Paper) on risk-mitigation techniques for OTC-derivative contracts not cleared by a central counterparty (CCP) under Article 11(15) of Regulation (EU) No 648/2012 on OTC derivatives, central counterparties and trade repositories (EMIR).

Under EMIR a legal obligation to clear certain types of OTC derivatives through CCPs has been introduced. However, not all OTC derivative transactions will be subject to the clearing obligation and therefore it is essential, also for the purposes of preventing systemic risk, that counterparties apply robust risk mitigation techniques to reduce counterparty credit risk.

The European Supervisory Authorities (ESAs) were mandated to develop common draft regulatory technical standards (RTS) covering three main topics: (1) risk-management procedures for the timely, accurate and appropriately segregated exchange of collateral; (2) procedures concerning intragroup exemptions; and (3) the criteria for the identification of practical or legal impediments to the prompt transfer of funds between counterparties.

As part of the process, the Consultation Paper seeks stakeholders' views on the RTS proposal.

The draft RTS consider the minimum international standards on margin requirements for non-centrally cleared derivative transactions issued by the Basel Committee for Banking Supervision (BCBS) and the International Organisation of Securities Commissions (IOSCO) in September 2013 which to the extent possible have been transposed into the RTS.

Comments to the Consultation Paper are requested to be submitted by July 14th 2014 at the latest.

Following this Consultation Paper, and on the basis of the relevant input received, the ESAs have indicated that they shall finalise their jointly developed draft RTS and submit them to the Commission before the end of 2014.

EMIR - Q&A Update

The European Securities and Markets Authority ("ESMA") published on May 21st and June 23rd 2014, two updates of its questions and answers document ("Q&A") on the Implementation of Regulation No 648/2012 on OTC derivatives, central counterparties and trade repositories (EMIR).

The updated Q&A of May clarifies, inter alia, the following issues:

  • Derivative transaction entered into at the level of the sub-fund of an AIF or UCITS: the sub-fund is the one that should be considered the counterparty and not the umbrella fund. As a result, the sub-fund would need a Legal Entity Identifier ("LEI") and be responsible for the reporting duties under EMIR. Otherwise the umbrella fund should be identified as the counterparty and declare its sub-fund as the beneficiary (General Question 1).
  • Status of counterparties covered by AIFMD: The Q&A now enumerates more clearly which entities covered by the AIFMD fall under EMIR (EU AIFs, Non-EU AIFs, AIFs managed by authorised or registered AIFMS, securitisation SPVs etc.) (General Questions 3 and 4).
  • Intragroup exemption: when a contract between a financial counterparty (FC) and another counterparty is entered into, the intragroup exemption may apply if the other counterparty, while not consolidated under the Capital Requirements Directive (CRD), is part of the same consolidated non-financial group as the FC (OTC Question 6).
  • Public Register:  A public register containing a list of the classes of OTC derivatives notified to ESMA was first published on ESMA's website on March 18th 2014 and is updated after each central counterparty (CCP) authorisation.  The public register will also include a list of classes subject to the clearing obligation after the entry into force of the RTS specifying the classes of OTC derivatives subject to the clearing obligation.

The update of June focuses on the reporting requirements (in the section Trade Repositories (TR)).

In particular, the amendments brought to TR questions 3a and 3b are of relevance to all financial counterparties trading OTC derivatives.

Regarding question 3a, on the information on collateral to be reported to TRs, the Q&A clarifies that:

  • the collateral should be reported at the total market value that has been posted by the counterparty responsible for the report. Therefore any haircuts or similar used by the receiver of the collateral and any fees or similar amounts should all be ignored;
  • all collateral for a single portfolio should be reported in one single currency value;
  • non-cash collateral should be reported as its current cash equivalent as evaluated at the moment of posting/amending the collateral;
  • the collateral should be the sum of any initial margin (or similar) posted by the reporting counterparty and any variation margin (or similar) also posted by the reporting counterparty;
  • the collateral reported should be just the collateral that covers the exposure related to the reports made under EMIR; and
  • the collateral should be reported as the total market value that has been posted by the counterparty responsible for the report irrespective of whether certain types of collateral might take a couple of days to reach the other counterparty.

Question 3a also clarifies that the deadline of the reporting is extended by 180 days for the reporting of information referred to in Article 3 of Regulation (EU) 148/2013, i.e. data on exposure. The resulting date is therefore August 11th 2014 with the first reports being due no later than the end of August 12th 2014 including the valuations and collateral as at the end of August 11th 2014.

Question 3b clarifies that:

  • the mark to market value should be based on the End of Day settlement price of the market (or CCP) from which the prices are taken as reference;
  • the mark to market value should represent the absolute value of the contract;
  • whenever a price is available for the valuation such valuation is to be considered as "mark to market"; and
  • when counterparties delegate the reporting, including valuations, they retain the responsibility for ensuring reports are accurate.

In addition to the foregoing five new questions have been added: the reporting valuations of swaps on structured products, the population of the collateralisation fields, the treatment of contracts with no maturity date, the way to fill in the notional amount field and the reporting on OTC Derivatives Novations.

EMIR - Frontloading Requirement

On May 8th 2014 the European Securities and Markets Authority (ESMA) sent a letter to the European Commission (EC) proposing that the frontloading obligation for OTC derivatives in the European Market Infrastructure Regulation (EMIR) is made significantly less strict.

In its letter ESMA seeks the EC's view on the suggested approach of frontloading.

The frontloading requirement is the obligation to clear OTC derivative contracts entered into after a central counterparty (CCP) has been authorised under EMIR and before the date of application of the clearing obligation.

According to ESMA this requirement may introduce significant uncertainties in the market with legal, operational and financial consequences which will be mainly borne by derivatives end-users.

ESMA has analysed that the over-all effect could be a reduction in the incentive to hedge risks during a certain period (to avoid the consequences of the frontloading effect), which would in turn increase the un-hedged risks and would impact negatively on financial stability.

In these circumstances ESMA considers that the reduction of systemic risk can be questioned if this obligation introduces at the same time risks to market functioning and financial stability.

A first notification was received by ESMA on March 18th 2014 of a CCP authorised under EMIR to clear certain classes of OTC and since that date, the counterparties which trade OTC derivatives contracts within those classes could become subject to the frontloading requirement and therefore resolving this issue is becoming urgent.

The frontloading window can be divided into two different timeframes:

  • Period A: between the notification of the classes to ESMA and the entry into force of the regulatory technical standards (RTS) on the clearing obligation;
  • Period B: between the entry into force of the RTS and the date of application of the clearing obligation. Period B is equivalent to the phase-in period to be defined in each RTS for each category of counterparty.

In its letter ESMA stresses that the uncertainty and negative impact of frontloading are most significant in Period A and it considers that a way to mitigate the negative impact of this requirement could be to apply the frontloading obligation only to contracts entered into during Period B since, during this period, counterparties will have the certainty on the scope and the date of application of the clearing obligation but also on the CCPs available.

ESMA will consider possible solutions in a public consultation paper which will be released prior to the finalisation of the draft regulatory technical standard on the clearing obligation.

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