EMIR Refit

Introduction

The EMIR Refit Regulation (EMIR Refit) will enter into force on June 17, 2019. With some exceptions, it will apply from that date.

The purpose of the EMIR Refit is to amend and simplify the European Markets Infrastructure Regulation (EMIR) “to address disproportionate compliance costs, transparency issues and insufficient access to clearing for certain counterparties.”

This note provides a summary of the key changes under EMIR Refit.

Definitions / scope

1. Definitions

EMIR Refit amends the definition of financial counterparty (FC) so that it captures alternative investment funds (AIFs) and their managers. An AIF will be a FC either if it is managed by an alternative investment fund manager (AIFM) authorised or registered under the Alternative Investment Fund Managers Directive (AIFMD) (the current position) or if it is established in the EU regardless of the location or status of its manager.

Non-EU AIFs with non-EU AIFMs will be reclassified as third country entities that would be FCs meaning that they become subject, on an indirect basis, to the margin requirements when trading with EU dealers.

The two points above will have a big impact for AIFs which have been classified as non-financial counterparties (NFCs), or would have been classified as NFCs if they had been established in the European Union. These entities will now be subject to all the EMIR obligations (unless they are a small financial counterparty (please see below)), and will need to notify derivative counterparties of the change to their counterparty classification.

Securitisation special purpose entities are explicitly excluded from the definition of FC.

There are also exclusions for central securities depositories and funds that serve share purchase plans.

2. Small financial counterparties

EMIR Refit creates a new category of financial counterparty (FC) known as the small financial counterparty (SFC). An SFC is exempted from the clearing obligation but remains subject to risk mitigation obligations, including margin requirements. Whether an entity is an FC or an SFC is determined using the same clearing thresholds that apply to NFCs. The determination needs to be made once a year and is based on the aggregate month-end average for the preceding 12 months. The initial calculation must be made as of the day on which EMIR Refit enters into force¹. Alternatively, FCs can elect not to undertake such calculations and notify their Member State competent authority (NCA) that they are not an SFC.

3. The clearing threshold for NFCs

EMIR Refit changes both the clearing threshold calculation procedure and the implications for NFCs in the event that they do exceed a clearing threshold.

The 30 day rolling average calculation is replaced with an annual calculation based on the aggregate month-end average position for the preceding 12 months. The initial calculation must be made as of the day on which EMIR Refit enters into force. If an NFC exceeds the clearing threshold, it will only be subject to the clearing obligation in respect of the asset class(es) in which has exceeded the clearing threshold. However, exceeding the clearing threshold in one asset class will make an NFC subject to the collateralisation requirement in respect of all asset classes.

NFCs which elect not to carry out the calculations will be treated as NFC+² in all asset classes, and for all EMIR obligations.

Clearing

4. NFC clearing

EMIR Refit provides that NFCs whose positions exceed at least one of the clearing thresholds will be subject to the clearing obligation only for the derivatives belonging to the asset class for which the clearing threshold has been exceeded. An NFC that exceeds the clearing threshold for one asset class would remain subject to the requirement to exchange collateral in respect of uncleared over-the-counter (OTC) derivative contracts in other asset classes.

5. Fair, reasonable, non-discriminatory and transparent terms

EMIR Refit introduces a requirement on clearing members, and clients providing indirect clearing, to provide clearing services on fair, reasonable, non-discriminatory and transparent commercial terms (FRANDT). In particular, they must take reasonable steps to manage conflicts of interests, especially between trading and clearing units, that may adversely affect the provision of clearing services on FRANDT terms. The European Commission (Commission) will adopt a delegated act specifying further what is meant by fair, reasonable, non-discriminatory and transparent, including the requirements regarding transparency of fees and contract terms.

6. Article 39 EMIR

Article 39 of EMIR is amended so that “Member States’ national insolvency laws shall not prevent a CCP from acting in accordance with Article 48(5) to (7) with regard to the assets and positions recorded in accounts referred to in paragraphs 2 to 5 of this Article.” This provision is designed to ensure that national insolvency laws do not prevent a central counterparty (CCP) from complying with existing client clearing obligations in respect of porting and liquidation of positions / assets recorded to client accounts. It does not bring in any changes to the existing EMIR client clearing obligations.

7. Information from CCPs

EMIR Refit obliges CCPs to provide its clearing members with a simulation tool allowing them to determine the amount of additional initial margin, on a gross basis, that the CCP may require on clearing a new transaction. The results of the simulation will not be binding.

8. Suspending the clearing obligation

EMIR Refit gives the Commission the power to suspend the clearing obligation for three months. Such suspension may be extended by a further three months, for a maximum aggregate period of 12 months. Any suspension would be extended to the Markets in Financial Instruments Regulation (MiFIR) trading obligation. Any suspension by the Commission is at the request of the European Securities and Markets Authority (ESMA), exercisable in certain prescribed circumstances.

Risk mitigation

9. Risk mitigation

Recital 35 of EMIR Refit states that the Commission should be empowered to adopt regulatory technical standards (RTS) developed by ESMA or the European Banking Authority concerning supervisory procedures to ensure initial and ongoing validation of risk management procedures that require the timely, accurate and appropriately segregated exchange of collateral.

Due to the complexity of these risk-management procedures by counterparties which involve the use of internal models, NCAs should validate those risk-management procedures or any significant change to those procedures, before they are applied. This is to avoid inconsistencies across the EU in the application of risk mitigation techniques.

Recital 21 of EMIR Refit states that it is appropriate to restrict the mandatory exchange of variation margins on physically settled foreign exchange forwards and physically settled foreign exchange swaps to transactions between the most systemic counterparties. This is to limit the build-up of systemic risk, avoid international regulatory divergence and the need for NFCs and SFCs to reduce the risks associated with their currency risk exposures. Counterparties are currently relying on regulatory forbearance regarding the application of EMIR’s variation margin requirement to physically settled foreign exchange forwards, as amendments proposed in December 2017 to Commission Delegated Regulation (EU) 2016/2251 of 4 October 2016 to take them out of scope of that requirement have not entered into force. The recital arguably sets out a path towards a formalised disapplication of the variation margin requirement to physically settled foreign exchange forwards and the expansion of that disapplication to physically settled foreign exchange swaps and, perhaps, other classes of derivatives.

Reporting

10. Reporting by financial counterparties

For OTC derivatives contracts, FCs will be solely responsible and legally liable for reporting on behalf of itself and NFCs that are not subject to the clearing obligation. The FC will also be responsible for ensuring the correctness of the details reported. To ensure that the FC has the data it needs, the NFC should provide the details relating to the OTC derivatives contracts that the FC cannot be reasonably expected to possess.

An NFC will also be exempted from reporting responsibility if it transacts with a third country entity that would be an FC if established in the EU, but only if the entity reports the transaction under its home country reporting regime, and that regime has been declared equivalent under Article 13 of EMIR.

NFCs may still choose to report their OTC derivatives contracts and in such cases, they should inform the FC. In such instances, the NFC becomes responsible and legally liable for reporting the data and ensuring its correctness.

11. NFC intra-group transactions

Recital 16 of EMIR Refit notes that intragroup transactions involving NFCs represent a relatively small fraction of all OTC derivative contracts and are used primarily for internal hedging within groups. In light of this intra-group transactions where at least one counterparty is an NFC will be exempt from the reporting obligation. Counterparties will need to notify their NCA that they intend to rely on this exemption.

12. Reporting by funds

Recital 19 of EMIR Refit states that the management company of a UCITS is responsible and legally liable for reporting on behalf of that UCITS with regard to OTC derivatives contracts entered into by that UCITS, as well as for ensuring the correctness of the details reported. Also, an AIFM is responsible and legally liable for reporting on behalf of the AIF with regard to OTC derivative contracts entered into by the AIF, as well as for ensuring the correctness of the details reported.

13. Backloading

The backloading requirement (to report transactions that were no longer outstanding when the EMIR reporting obligation came into effect) is removed by EMIR Refit.

14. Frontloading

At present, OTC derivatives contracts must be cleared if they have been entered into before the clearing obligation takes effect, provided the contracts were entered into after a specified date and have a remaining maturity which is higher than a minimum specified by the Commission when introducing the clearing obligation. EMIR Refit removes this requirement.

15. Trade repositories

EMIR Refit provides that trade repositories shall establish the following procedures and policies:

• Procedures for the effective reconciliation of data between trade repositories.
• Procedures to verify the completeness and correctness of the data reported.
• Policies for the orderly transfer of data to other trade repositories where requested by counterparties or CCPs.

Further guidance

16. ESMA Q&As

On May 28, 2019, ESMA updated its Q&As on EMIR providing new answers in the implementation of EMIR Refit with regards to:

• The clearing obligation for FCs and NFCs.
• The procedure for notifying when a counterpart exceeds or ceases to exceed the clearing thresholds.
• How counterparties should report derivatives novations and removes some obsolete references to frontloading when populating field “Clearing Obligation”.

Timing

17. Timing

EMIR Refit comes into force on June 17, 2019.

Whilst some of the changes introduced by EMIR Refit apply upon the Regulation entering into force (for example the changes to the definition of FC) other requirements are phased in. These include:

Brexit

18. Brexit

The Financial Services (Implementation of Legislation) Bill is designed to give the UK Government the power to implement and make changes to ‘inflight’ files of EU financial services legislation. The powers will last for two years after the UK withdraws from the EU, in the event of a no deal scenario. When the Bill was introduced into Parliament earlier this year with the real prospect of the UK leaving the EU on March 29, EMIR Refit was clearly one of the inflight files that would be captured. However, given that it is now unlikely that the UK will leave the EU before EMIR Refit comes into force on June 17, 2019, the Regulation will become directly applicable. In light of this, in a hard Brexit scenario occurring after 17 June, EMIR Refit is expected to be onshored into UK legislation via a statutory instrument made under the European Union (Withdrawal Act) 2018.

Should the UK leave the EU at the end of October 31, 2019, one particular issue concerns the technical standards under EMIR Refit. If the UK leaves the EU on this date without a deal, the technical standards may still be in draft form and the UK’s ability to influence them will be significantly reduced. However, the UK may find itself in the same position should it leave the EU with a deal on this date as during the transitional period whilst being subject to EU law, the UK is no longer a Member State and its regulatory authorities would no longer sit on the European Supervisory Authorities. It is also worth noting that the UK Government would not have a vote if the new suspension mechanism were to be triggered during the transitional period, since such a suspension must be approved as an Implementing Act by a qualified majority of EU Member States only.