The recently published thresholds for centrally clearing over-the-counter (OTC) derivatives is another trigger point in a long line of legislation to address market risk through the European Markets Infrastructure Regulation (EMIR). Corporates need to sit up and take notice, for this affects them.
On 15th March, the technical standards supplementing the European Markets Infrastructure Regulation (EMIR) entered into force. According to the European Securities and Markets Authorities (ESMA), the main obligations under EMIR are:
Central clearing for certain classes of over-the-counter (OTC) derivatives.
Application of risk mitigation techniques for non-centrally cleared OTC derivatives.
Reporting to trade repositories.
Application of organisational, conduct of business and prudential requirements for central counterparties (CCPs).
Application of requirements for Trade repositories, including the
duty to make certain data available to the public and relevant
The latter publication is of paramount importance to treasurers, for it lays out exactly what EMIR means for corporates that enter into derivative contracts. These compliance obligations can be grouped into three categories:
Reporting– applies to all corporates engaged in the derivatives business.
Central clearing– applies if the corporate exceeds the clearing threshold.
Risk mitigation– applies to those derivative classes not subject to the clearing obligation.
Corporates must report derivative contracts – new contracts, changes to existing contracts and termination of contracts – to a recognised trade repository no later than the following working day. Reporting can be delegated to a counterparty or third party.
If a corporate exceeds the clearing threshold, then it will need to centrally clear “those OTC derivative contracts that are subject to the clearing obligation”. Derivative classes that don’t count towards the clearing threshold are those “entered into in order to reduce risks relating to the commercial or treasury financing activity of the non-financial entity”.
The value of the clearing thresholds are:
€1 billion* credit derivative contracts.
€1 billion* equity derivative contracts.
€3 billion* interest rate derivative contracts.
€3 billion* foreign exchange (FX) derivative contracts.
€3 billion* commodity derivative contracts and others.
There is a range of risk mitigation obligations, such as the timely reporting of the confirmation of the trade, dispute resolution obligation, portfolio reconciliation/compression obligations and, most importantly, the posting of margin collateral. Corporates must evaluate and report, possibly on a daily basis, its collateral and positions it holds with other counterparties, who are obliged to route this to the CCP.
According to Alexander Schwenk, a Banking and Capital Markets Lawyer at Norton Rose, corporate treasurers need to take a number of actions now that these regulatory technical standards have come into force. The first step is to determine who should assume responsibility for the EMIR implementation project. Although in most cases it may make perfect sense for the treasury to take ownership, if the company is a commodities trader then maybe the traders may look after it, or some may argue that because it is regulation that legal should control implementation.
No matter who is ultimately in charge, it is important to implement a project which involves all company departments, particularly for the purpose of calculating the clearing threshold. “It is possible that if treasury doesn’t know what the trading unit is doing and the company exceeds the threshold in one class of derivatives, then the entire company will become subject to the clearing obligation, even if they don’t exceed the clearing threshold in respect to another class of derivatives,” explains Schwenk.
A number of corporates are waiting to see how things develop, which could theoretically be considered a legitimate approach since EMIR has been postponed a number of times and the different compliance obligations have differing implementation deadlines. “We are still waiting for a number of trigger points to be established,” explains Schwenk. However, once they are established corporates may have to react quickly because the implementation – or the phasing-in period – for the various compliance obligations may become quite short.
The lack of clarity on a number of issues has contributed to corporate confusion. For example, corporates may be able to benefit from group exemptions, particularly in terms of risk mitigation obligation and margin posting, according to Schwenk. “Group exemptions are precisely defined under EMIR and if a corporate can benefit from group exemptions then it will have to apply for an exemption, or file a notification, to the relevant national competent authority (NCA). A number of corporates are asking when can they file the group exemption notification under EMIR – is it already possible now or do they need to wait until the class of derivatives that they are trading in has been defined by ESMA? This is one of the questions we have been looking at.”
Another unresolved question is what transactions are considered hedging transactions or, as EMIR states, are eligible from an objective point of view to reduce risks, so will not to be counted towards the threshold. “One of the most prominent exemptions in this respect is hedge accounting, where companies are accounting these transactions under the International Financial Reporting Standards (IFRS) hedge accounting regime, which is a safe harbour under EMIR,” says Schwenk.
The third point is the clearing obligation itself. “Corporates will have to closely monitor which CCPs will be licenced,” says Schwenk.
Still to come
Important regulatory technical standards still to come are the ones for margin requirements for non-centrally cleared derivatives. At the end of February, the Bank for International Settlements (BIS) and International Organisation of Securities Commissions (IOSCO) have submitted a paper as to how this could be implemented on a global scale. ESMA has been waiting for this and are now working on these standards.
“If people are talking about a collateral crunch these days, BIS and IOSCO have tried to alleviate this,” says Schwenk. “They have stepped back from very strict collateral requirements, in order to make it possible for a range of market participants to have enough collateral to post. So they are thinking of a collateral threshold for the posting of margins, which may be in the range of €50m.”
This insight was first published on www.treasurytoday.com