EMIR: the ‘European Market Infrastructure Regulation’

EMIR: the ‘European Market Infrastructure Regulation’

The European equivalent of the Dodd-Frank act is EMIR: the ‘European Market Infrastructure Regulation’, which was enforced on the 16th of August 2012. Its objective is to reduce the systemic risk in the financial markets. One thing is for sure: the rules of the game are changing.

After several disclosures of financial misdeeds at large multinational corporations and investment banks during the last few decades and as a result of the financial crisis, the regulatory requirements towards transparency, compliance and accountability have increased. In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed by president Obama to promote the financial stability of the United States by improving accountability and transparency in the financial system.  The European equivalent of the Dodd-Frank act is EMIR: the ‘European Market Infrastructure Regulation’ which was enforced on the 16th of August 2012. Its objective is to reduce the systemic risk in the financial markets. EMIR will bring change to the European financial landscape, especially for financial institutions and corporates trading over-the-counter (OTC) derivatives for non-hedging purposes as they will need to centrally clear their OTC derivatives through a Central Counterparty (CCP). The big question is: are all corporates aware of the impact EMIR will have on their company and are they ready for it?

EMIR distinguishes two groups of corporates: Non Financial Counterparties above the threshold (NFC+) and Non Financial Counterparties below the threshold (NFC-). NFCs exceeding the threshold are enforced to centrally clear (all) their OTC derivative portfolios with a CCP if the gross notional value of one OTC derivative portfolio exceeds the threshold (> EUR 1 billion for credit and equity derivatives and > EUR 3 billion for interest, FX and commodity derivatives). Those OTC derivatives that are not used for speculation, investing or trading do not need to be taken into account in the threshold calculation. This means that companies will need to construct reports to calculate the value of their derivative portfolios and to monitor if they are still within the thresholds, given they do not have these reports readily available. A CCP might not be able to clear all OTC derivative classes; as a result, a corporate might need to clear via multiple CCPs and thus connect their systems with multiple CCPs as well! The second category, the NFC below the threshold, is not subject to the central clearing obligation.

An additional requirement under EMIR is that all NFCs, regardless of the size and purpose of their derivative portfolio, need to apply risk mitigation techniques for all their OTC derivative portfolios that are not centrally cleared. The three risk mitigation techniques which are obligatory for all NFCs are: timely confirmation, portfolio reconciliation and dispute resolution. The fourth technique, portfolio compression, is voluntary and daily mark-to-market reporting, the fifth one, is only applicable for NFCs above the threshold. If you are not currently performing these techniques, you will be obliged to when EMIR becomes effective!

Finally, NFCs are also required to report (no later than the following business day) specific details of the derivative contracts they have entered into (e.g. currency, nominal amounts), including every change to or termination thereof to a Trade Repository. As these report requirements are quite extensive and specific, a number of new reports will most likely need to be constructed, preferably in a company’s treasury or risk management system. Corporates are allowed to outsource these reporting activities to a third party.

Although the expectation is that corporates will centrally clear and report to Trade Repositories by the end of 2013, there is still a lot to be done. The main challenge is the fact that the Trade Repositories and Central Counterparties still need to be established and registered. Additionally, corporates will need to make the necessary changes to their processes and systems to become EMIR compliant. How challenging this will be depends on the ability and readiness of your treasury or risk management system to assist you on becoming EMIR compliant; e.g. run the central clearing, check clearing thresholds, connect to Trade Repositories and support risk mitigation techniques. One thing is for sure: the rules of the game are changing. Zanders is implementation partner for many treasury and risk management systems and can assist you in creating this new functionality. We have extensive experience in implementing risk mitigation techniques and can assist you on constructing the required reports. If you are not yet sure what the impact of EMIR will be on your company, we can perform an analysis of this impact and help you construct a plan to become EMIR compliant.