Analysis – EMIR RTS on OTC Derivatives and Trade Repositories vs points raised by ISDA-AFME-BBA in response to CP of June 2012
ISSUE / Concerns re CP / Concerns in RTS 27 SeptClearing Obligation Procedure – Notification to ESMA (Chapter III, Article 5) / Concern expressed that an EMIR Article 89.5 Notification to ESMA (transitional arrangement allowing CCPs authorised under national law but not yet under EMIR) - allowing CCPs to continue clearing pending application to EMIR authorisation – could trigger the frontloading obligation.
ISDA
- suggested that ESMA reflect the RTS recital 7 statement that ESMA should assess the ability of active counterparties to comply with the clearing obligation in Article 1.29(f) DET.
- Asked that the historical data lookback period be a minimum of 12 months (rather than being set at 12 months).
- Suggested that competent authorities should always have to submit a new notification to ESMA where market conditions or other relevant information for a notification (either already approved or not yet processed) changes.
- Asked that ESMA publish details of negative assessments regarding notifications.
No change.
Resolved – lookback period is now minimum 12 months.
No change.
No change – ESMA simply say that if, after 6 months, there is no mention of the clearing requirement for the class of derivatives in the Public Register, there has been a negative assessment.
Also of note: final RTS require CCPs to provide all of the above info to competent authorities.
Clearing criteria (Chapter IV – Article 6) / We suggested that ESMA should consider impact of market liquidity of making a class of derivatives subject to clearing, in particular that a class should not be made subject to clearing where liquidity will be reduced by such a decision. / No change in the RTS – suggestion was not taken up. Regarding volume and liquidity of the class, ESMA must simply (as stated in the CP)consider ‘the stability of the market size and depth…over time’ and the ‘likelihood that market dispersion would remain sufficient in the event of the default of a clearing member’.
Public Register (Chapter V –Article 7)) / Details of classes of derivatives in the register (Art 1 PR) should include:
- Any details distinguishing contracts in a class of derivatives subject to clearing from contracts that are not of that class and not subject to clearing;
- Names and codes for CCPs authorised to clear a specific class on the register.
- Apparent omission of contracts identified for clearing under the top-down procedure (art 6.2(d) EMIR)
- Apparent omission of contracts that may have to be frontloaded, having a remaining maturity over that the level assigned by ESMA (art 6.2(e) EMIR);
- Apparent omission of details pertaining to CCPs notified to ESMA that have been authorised for the purpose of the clearing obligation (art 6.2(f) EMIR).
Resolved? – Public Register now contains info on CCPs notified to ESMA, pertaining to the identification of the CCP, the asset class of OTC derivative contracts notified, types of OTC derivative, date of notification and identification of the competent authority.
No change apparent in RTS.
No change apparent in RTS.
Resolved? – Public Register now contains info on CCPs notified to ESMA, pertaining to the identification of the CCP, the asset class of OTC derivatrive contracts notified, types of OTC derivative, date of notification and identification of the competent authority.
Resolved? – PublicRegister now contains info on CCPs notified to ESMA, pertaining to the identification of the CCP, the asset class of OTC derivative contracts notified, types of OTC derivative, date of notification and identification of the competent authority.
Non-Financial Counterparties (Chapter VII, Articles 9 and 10) / Concern that it should not be the responsibility of FCs and NFC+s to monitor whether a clearing obligation should apply to their counterparty (e.g. NFCs that may not be disclose (or themselves monitor) whether they are above the threshold.
Call for ‘working day’ to be defined.
Seeks amendment to description of hedging contracts – so that reference to risks arising from potential changes in value is supplemented by reference to changes in the ‘variability of cash flows or costs’.
Calls for risks hedged through legitimate hedging contracts - for purpose of contracts that don’t count towards the threshold - to be amended to include credit risk, equity risk, transport, storage or commodity risk.
Calls for explicit permission for NFCs who are not required to use IFRS to be allowed to use local GAAP rules, not only for satisfying hedge accounting rules under local GAAP but also to demonstrate their hedges meet the ‘objectively measurable…’ requirement for purpose of monitoring their position vs the clearing threshold.
Accounting terminology: calls for change of terminology: from ‘hedging contract’ to ‘hedging instrument – in line with IAS 39.
Calls for clarification of term ‘proxy hedging’ or use of ‘macro hedging’ instead.
Calls for clarification that risks linked to ‘commercial activities or treasury financing activities’ for the purpose of the defining hedges should include any genuine hedging of operations and only exclude speculative trading e.g. use of equity hedging for hedging stock option plans or share buyback schemes.
Calls for removal of references to ‘trading’ and ‘investment’ with regard in the description of the types of contracts that cannot be seen as hedging contracts.
Calls for guidance from ESMA regarding availability of hedging exemption for SPVs.
Consequences of exceeding threshold:
-Call for alignment with CFTC on a number of issues including on some CFTC thresholds for MSP, especially ‘potential outward exposure’;
-Concern at ‘exceed one threshold, clear everything’ approach – unlike US approach where hedging contracts are provided with a safe harbour and do not have to be cleared. Questions ESMA’s suggestion that it has no discretion on this point.
-Suggest EU is placing itself at a disadvantage on this point.
Suggests giving NFCs the option of calculating derivatives exposure by reference to net exposure (as gross notional value is not a valid risk measurement). Calls - at very least – for provisions to be introduced allowing NFCs to net any intragroup positions and 3rd party offsetting positions where contracts have effectively closed each other out.
Further to previous point, calls – if notionals are to be used as the metrics for the threshold – for the thresholds for each asset class to be aligned with the typical underlying exposures of each asset class.
Suggest better definition of each asset class for the purpose of the thresholds – and cross-reference to MIFID annexes. Calls for separate threshold for commodity derivatives.
Seeks guidance on treatment of multi-asset class derivatives (e.g. cross-currency interest rate swaps).
Seeks clarity on treatment of short-dated FX contracts. Will they be excluded from the clearing threshold calculations?
Calls for exclusion of long-dated commodity derivatives from calculations towards the clearing threshold.
Calls for annual review of thresholds (rather than just ‘regular’) and high thresholds to start with (given lack of data). / No change – and reporting requirement for financial counterparties to get information from NFCs as to whether they are above the threshold or using a hedging transactions reinforces the concern.
No change – though the reference to ‘working day’ is in the EMIR Regulation and not the RTS.
No change apparent.
Credit risk now explicitly included. Some references to commodity risk were already in the text. ESMA intention – as explained in the explanatory statement – was to allow equity derivatives as hedging tools – though not clear that the text has been changed to reflect this fact. No change apparent regarding transport or storage risk.
No change apparent- recital 16 states that for ‘non-financial counterparties that may use local accounting rules, it is expected that most of the contracts classified as hedging under such local accounting rules would fall within the general definition of contracts reducing rusk directly related to commercial or treasury financing activity…’
No change apparent.
Recital 17 may offer some comfort, indicating that proxy, macro and portfolio hedging should be covered by the definition of hedging activity.
Explanatory statement indicates that hedging of equity price risk (e.g. for hedging risk associated with employee share schemes) should come within scope of hedges that are considered within ‘normal’ course of business (note: this is a change from the CP which referred to ‘ordinary course of its business’) and don’t count towards the clearing threshold. Not necessarily clear that legal text achieves this goal, but explanatory statement may be helpful in this regard.
Resolved – the entire paragraph which gave concern has been removed from the text.
No guidance is apparent. Exemption or otherwise would seem to depend on the nature of the derivatives activity of the SPV, although the new allowance for hedging of credit risk may be helpful.
No change.
No change – just insertion of word ‘gross’ to underline the thresholds are set in ‘gross notional’ terms. Arguably this contradicts the level 1 mandate. Recital 22 justifies this by stating that the gross notional and the sum of net positions numbers are similar numbers because of the directional nature of hedges by non-financials – though this is not true.
No change.
No change.
No change.
No change – no clarification offered.
No change – no clarification offered.
No change – ‘periodic’ review promised in recital 20.
Risk Mitigation Techniques: Timely Confirmation (Chapter VII, Article 11) / Stated understanding that the confirmation requirement refers to issuance (dispatch) of a confirmation and not the full legal execution, and this may simply be a form (i.e. a term sheet) which need not include the exact legal text required for the final confirmation provided it contains core economic terms, methodologies etc for determining the terms.
Sought clarification that confirmation requirement does not apply to intragroup trades.
Sought clarification regarding meaning of ‘concluded’ for the purpose of determining the point in time from which the issuance of a confirmation is concluded (meaning is not that clear). Suggestion that contract should not be deemed concluded until such time as all relevant allocations and other core economic terms have been agreed.
Sought clarification in the text that one counterparty can delegate its confirmation obligation to another.
Regarding requirement for – where available – confirmation by electronic means – sought confirmation on meaning of ‘where available’ (e.g. where local requirements require transactions on paper?).
Sought clarification of effect of text regarding 16:00 time limit where counterparties are in different timezones or ops infrastructure is in different location to a firm’s traders. Suggest that cut-off should be triggered by the first time-zone of either counterparty or its operating infrastructure, to reach 16:00.
Suggested easier requirements for NFCs than those set out
Stated concern about over-aggressive timelines, if confirmation as set out is to be in final executable form or fully executed by both counterparties.
- Call for flexible, phased approach early on,focused on asset class, product type and counterparty type.
- Some agreements require an MA or MCA, often encompassing more than a single contract – this should be allowed for, with more time allowed for this alternative approach.
- Allowance should be made for firms which are not subject to EMIR – timelines for in-scope firms dealing with such firms will be more challenging.
- Regarding the report on unconfirmed transactions, clarification sought on date of commencement of 5 day period and that the report is based on a snapshot.
Recital 36 suggests that intragroup transactions are not subject to confirmation requirements (nor other non-margin risk mitigation requirements).
See recital 25 for meaning – not fully satisfactory?
Explanatory statement paragraph 88 confirms this, though it is not confirmed in the text.
No change here – no clarification provided.
Allowance for one extra day at most where transaction is concluded after 16:00 or where counterparties are in different timezones.
Some easier, scalable requirements apparent, but insufficiently so.
Phased approach is apparent, but insufficiently so. Equity derivatives targets apparently not achievable. The date of application is currently scheduled for January 2013(unlike other non-risk mitigation requirements, where another 6 months is allowed for preparation) which may be completely impractical, for compliance purposes.
No such allowance is apparent.
Requirements seem insufficiently tailored for dealings with NFCs below threshold. Extra time allowed is insufficient.
No clarity here – firms must simply have ‘the necessary procedure’ for this report.
Likely application date of January 2013 unachievable?
Portfolio Reconciliation, Chapter VIII, Article 12 / Intragroup trades should not be subject to portfolio reconciliation with counterparties – should be dealt with internally (no risk mitigation purpose).
Oppose mandatory reconciliation of portfolios with less than 300 trades (costly, not justified by risk, not convergent with dispute resolution requirements/convergence).
Suggest measurement of portfolio size on quarterly basis.
Suggest no need for agreement in writing between CPs regarding terms of portfolio reconciliation, in light of level of prescription in RTS.
Calls for recognition that 100% compliance cannot be achieved – especially because of transactions with non-regulated firms – but commits to good faith and commercially reasonable effort. / Recital 36 suggests that intragroup transactions are not subject to portfolio reconciliation requirements (nor other non-margin risk mitigation requirements).
Text has worsened in some respects – in line with CFTC requirements – so now portfolios between 51 and 499 trades must be reconciled once per week.
No change.
No change.
No change.
Portfolio Compression, Chapter VIII, Article 13 / Article does not mandate compression but requires that there be procedures in place for counterparties with over 500 contracts outstanding with a counterparty to assess the scope for conducting a compression exercise.
Made remarks about:
- Limited impact of compression on counterparty risk.
- Greater suitability of compression for some asset classes than others.
- Existing industry tools not accessible to all market participants, and where compression has been successful, this (and homogeneity of firms that have access) is one of the reasons why.
ESMA fully deleted the requirement to terminate contracts at the end of a compression exercise.
Dispute Resolution, Chapter VIII, Article 14 / Generally supportive of requirement for procedures and processes to be in place to resolve disputes, and of view that industry dispute resolution requirements fulfil this purpose.
Suggested removal of references to third party arbitration and market polling as these accord more priority to these processes than others that may be more suitable.
Suggested clarification with regard to ensuring understanding that timeframes for dispute resolution relate to proceduresfor dispute resolution rather than achieving settlement with regard to the appropriateness of the settlement, and to clarify that the €15 million threshold refers to the disputed portion and not the entire amount of collateral being called.
Also called for clarification of periodicity of reporting, hinting preference for monthly reporting. / These references were removed from the Article, but persist in the recitals.
Some helpful clarification provided that timeframe refers to procedures for dispute resolution rather than achieving settlement (Article 14.1(b)
No change – no clarification provided.
Market conditions preventing mark-to-market, Chapter VIII, Article 15 / View that draft RTS were generally ‘reasonable’.
However call for
- Alignment of ESMA standards with paragraph B37 of IFRS 13 (and consistency with overall fair value hierarchy in IFRS 13 and US equivalent FASB 157);
- Conditions in which marking-to-model rather than marking-to-market can be allowed should be more flexible to take into account of different factors across more or less mature markets (we proposed examples and legal text herein).
Criteria for using marking-to-model, Chapter VIII, Article 16 / Suggestion
- That in relation to ‘accepted economic methodologies’, there be clarification that such methodologies are subject to interpretation of the financial institution in question and that such institutions can rely on third parties (for valuation) in this context.
- That more clarity be provided on meaning of ‘independence’ from the division taking the risk.
- Of concern that the basis of the calculation of the model should be transparent, flexible so as to reflect the specifics of the market and class of OTC derivatives.
Intragroup transactions – details of notifications to competent authorities + details of notifications by competent authorities to ESMA – Chapter VIII, Articles 17 and 18 / Notification to competent authorities
- Noted that there were hard deadlines (2 months) set (in the CP) for competent authorities to respond to applications pursuant to articles 11(8) EMIR (intragroup transactions between counterparties in the EU and in a 3rd country jurisdiction) and article 11(10) EMIR (intragroup transactions in mixed groups where counterparties are in different Member States) but deadlines for response are not as definitive for other types of intragroup trade (e.g. those in article 11(6) EMIR ((financial) counterparties in different Member States). Called for clear consistent deadlines herein.
- Asked for clarification on the meaning of ‘practical and legal impediments’ for the purpose of benefiting from the exemption. The mandate seemed to allow scope for clarification of this point, though it wasn’t explicitly mandated.
- Implicitly sought guidance on how requirement for ‘legal opinions or summaries, copies of documented risk management procedures, historical transaction information , copies of the relevant contracts between the parties’ would be interpreted and implemented by competent authorities.
- Concern expressed regarding mention in article 7 RM of competent authorities requesting in writing ‘where further information is required’ for checking fulfilment of the conditions for benefiting from the exemption. Also concerns about commercial confidentiality/sensitivity of information sought?
- Posits that the notification – for all types of intragroup transaction covered (whether the exemption requires merely a notification or a rather a positive decision) - applies to the relationship between the counterparties, and applies to transactions in the future, until and if either or each of the counterparties no longer fulfils the associated conditions, upon which they must inform the competent authorities.
- Suggests that the exemption should no longer apply as soon as the counterparties cease to meet the conditions.
- In fact – all deadlines for response seem to have been removed now. While the CP set deadlines for response re intragroup transactions between counterparties in the EU and in a 3rd country jurisdiction and intragroup transactions between counterparties in the EU and in a 3rd country jurisdiction there now no deadlines set for regulators’ response to any transactions (in fact, ESMA had seemed to go beyond their mandate on this point in the CP, where they were only tasked with addressing details of notifications to competent authorities pertaining to article 11(10) EMIR and to article 11(5) EMIR (intragroup trades between counterparties in the same Member State) and article 11(9) EMIR (intragroup trades within mixed groups where an NFC is in Europe and another counterparty is in another jurisdiction).
- No clarification has been provided on the meaning of ‘practical and legal impediments’.
- Legal opinions only have to be provided when requested by competent authorities – apart from this, no clarification is provided.
- The article no longer refers to the possibility for regulators to ask for further information. Not clear whether this is positive or not (if regulators are not happy to allow exemption unless they receive further information, the exemption could be refused in the absence of receipt of this information)?
- Although the relevant article doesn’t seem to explicitly address this point, the explanatory statement does (paragraph 120) confirms our understanding is that regulators are working towards a solution whereby the exemption is granted on a relationship basis.
- Not explicitly addressed.