As a response to the 2007-10 global financial crisis, the US passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (aka Dodd-Frank) in 2010 with the goal of regulating trade in over the counter (OTC) derivatives. The European Union (EU) is following suit with the European Market Infrastructure Regulation (EMIR), (EU) 648/2012. From February 2014, EMIR requires companies to report OTC derivatives to a certified trade repository. This requirement also applies to internal derivatives that are traded between corporate headquarters and subsidiaries, with the aim of making transactions between participants more transparent and to facilitate control to regulation.
Companies whose derivatives exceed given thresholds also have to clear them via a central clearing house. Even if the clearing threshold is not crossed, all companies that trade OTC derivatives will have to ensure – within the scope of their risk management – that the clearing threshold is not exceeded. Furthermore, the market value of the derivatives has to be calculated regularly by parties maintaining certain derivative volumes in order to be able to report on it.
Challenges for Treasurers
These new regulations mean additional challenges for treasurers. They have to adjust their processes and software solutions to meet the new regulatory obligations, choose and pay a trade repository and eventually regularly perform market value calculations in the future. If companies have to consolidate derivatives from different systems, the effort to comply is usually even greater.
According to a recent study by the SAP consulting company SymQ, European treasurers were still rather hesitant in their preparations for EMIR in late 2013. This can probably be explained by the many postponements of the deadline by the European Securities and Markets Authority (ESMA) and by the fact that the first trade repositories were certified only recently.
At the time of the study in October, less than half the treasurers surveyed were already using a treasury management system (TMS) for administration of their OTC derivatives. Most were having to consolidate the relevant data from dispersed systems or, worse still, manage the derivatives entirely manually. In view of the fact that of those surveyed only 9% reported they had already started to adapt their IT systems and contracts, much remains to be done before the deadline.
Treasurers dealing with OTC derivatives will need to have the following implemented in time for the EMIR reporting deadline of 12 February 2014:
- Reporting requirement: all OTC derivative transactions have to be reported to a certified trade repository by 12 February 2014.
- Back loading of historic derivative deals has to be completed by 13 May 2014.
- Clearing obligation: organisations exceeding certain thresholds with their derivatives have to clear their OTC transactions via a central counterparty (CCP) by September 2014 (expected) .
Added Value for Corporate Treasuries
By complying with regulation forward-thinking treasuries exploit EMIR’s challenges to add value to their operations. First, by automatically compiling the deal information for the regulator the treasurer increases transparency over his/her own OTC business, and this gain in transparency may help to compensate for the anticipated increased costs of hedging.
Observation of the clearing thresholds does serve as a means of counterparty exposure in foreign exchange (FX), while adding valuation helps sharpen counterparty exposure management over other risk types, too. In conjunction with the exposure to be hedged from operational business, a full-scale exposure management can be established. Last but certainly not least, by analysing the risk mitigation techniques and not only the minimum requirements, processes in risk management can be implemented or upgraded to refine the company’s hedging instruments and strategy.
How to Tackle the Challenges
An automated solution helps companies to ensure a complete overview of derivatives that have to be reported and supports the reporting process without having to take a detour via banks or external providers. An SAP approach for EMIR reporting lends itself to companies that manage OTC derivative transactions directly in SAP. Specialised treasury management solutions for SAP and for enterprise resource planning (ERP)-independent systems provide added value through an extended automation and centralisation of the reporting process and beyond.
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