Even those who have a perfect understanding of how EMIR will
affect them are facing challenges when it comes to forming an action plan to
become EMIR compliant. This article summarises the EMIR regulation and points
out the most important actions that market participants need to take.
Impact on Non-financial Counterparties
EMIR mean for corporates and public sector organisations? Firstly, two groups
of non-financial counterparties (NFCs) are identified based on whether they do,
or do not, exceed a threshold. These two groups are called NFC+ and NFC-
respectively. The first group is forced to centrally clear all their
over-the-counter (OTC) derivative classes since the gross notional value of at
least one OTC derivative class exceeds a certain threshold. The second group is
not enforced to centrally clear since none of their OTC derivative classes
exceeds the defined threshold. Only OTC derivatives that are used for
speculation, investing or trading need to be taken into account in the
threshold calculation. The European Securities and Markets Authority (ESMA)
provides a form to communicate when a NFC- becomes NFC+ by breaching the
threshold and another one to communicate that the threshold is no longer
Secondly, both NFC+ and NFC- entities need to apply risk
mitigation techniques such as (timely) confirmation, portfolio reconciliation
and dispute resolution for all their OTC derivatives that are not centrally
cleared. NFC+ companies are also obliged to calculate on a daily basis the
mark-to-market value of each derivative that is not centrally cleared, as
outlined in the table below.
Thirdly, all NFCs must report no later
than the following business day the details of every derivative contract that
they enter into and every change to or termination thereof to a trade
repository (TR). This means that all derivatives need to be reported,
regardless of whether the contract falls under the central clearing requirement
(CCR) or not. Yet ESMA has not officially communicated that point yet. It seems
that the deadline to report exchange-traded derivatives to the TR has been
postponed until the 1 January 2014. The above information is summarised in the
next table below.
Impact on Financial
While the EMIR reporting obligations do not
differ from those of NFCs, the central clearing obligations for financial
counterparties (FCs) do present some important differences.
FCs entering into OTC derivatives with other FCs or NFCs+ are forced to
centrally clear, regardless of being above or below a certain threshold.
However, FCs are not obliged to centrally clear if they enter into OTC
derivatives with a NFC-.
Secondly, in addition to the aforementioned
risk mitigation techniques, FCs must calculate on a daily basis the
mark-to-market (MTM) value of each derivative that is not centrally cleared.
The above information is summarised in the third table below.
The EMIR obligations are a clear
challenge for all market participants, from both an organisational and
operational perspective. From an organisational perspective, market
participants may have to reorganise roles within their teams in order to
execute new tasks required by EMIR. Moreover, market participants who do not
execute portfolio reconciliation and dispute resolution have to allocate
resources to cover these collateral management processes. Those organisations
with the obligation to centrally clear also have to reorganize roles to cover
this new process. Without doubt, the same applies to the process of reporting
to a TR.
From an operational perspective, the obligation to
centrally clear is a challenge for many market participants. Not all market
participants falling under this obligation have systems capable of calculating
and reporting the breach of a threshold. The possibility of using a system in
order to execute central clearing with central counterparties (CCPs) is also
something that many market participants lack at the moment.
mitigation techniques are also a challenge for many market participants, since
not all of them have both the processes and the systems to execute risk
mitigation as required by EMIR. Without doubt, the regulation is very
technically demanding and challenging for all market participants. No market
participant currently has a system that enables the extraction of the required
data and the reporting of it to a TR without custom developments.
Last June ESMA announced that TRs would
most probably receive their licence around late August 2013 rather than late
June 2013. The following month, ESMA postponed this announcement to the 24
September. Catching everyone by surprise, ESMA then announced on 13 September
another extension of the deadline by communicating that the first TR would not
be registered under ESMA before 7 November. This has pushed the deadline for
market participants to start reporting all derivative classes to 12 February
2014. This deadline is only applicable for the reporting of OTC derivatives.
ESMA officially announced on 8 August that the deadline for reporting exchange
traded derivatives (ETDs) to TRs has been postponed until 1 January 2015. ESMA
is expected to publish the exact number of TRs and their names at the moment of
giving the licenses.
FCs and NFCs+ may need to work with more than
one CCP if the chosen CCP does not offer clearing services for all OTC
derivative classes. National clearing associations (NCAs) are expected to
authorise CCPs between September 2013 and March 2014. At the moment there is no
concrete deadline officially announced by ESMA for market participants to start
central clearing. Again, ESMA is expected to publish the exact number of CCPs
and their names when it grants the licences.
participants should already be compliant with the risk mitigation techniques.
Timely confirmation was due on 15 March 2013 and the rest (portfolio
reconciliation, portfolio compression, dispute resolution and daily MTM) were
due on 15 September. ESMA has not yet specified what the penalty will be for
non-compliant market participants.
Implementing Trade Repositories
Knowing the obligations
and the deadlines is unfortunately not enough for becoming EMIR compliant.
Market participants should be currently allocating resources to select a TR and
CCP and to implement the (IT) infrastructure that will enable them to become
Which bridges need to be crossed before an
organisation becomes EMIR compliant? The first decision to be made with respect
to reporting is whether reporting to the TR will be delegated to a third party
or not. Although partial delegation is possible, from a pragmatic point of view
full delegation or no delegation at all seem to be the most likely options that
market participants will choose.
If an entity decides not to
delegate the reporting to a third party, evaluating all the existing TRs to
select one of them may become a cumbersome activity, due to the high volume of
information that needs to be assessed. ESMA has made market participants’ lives
easier by drawing up a short list of TRs based on the ones that will initially
receive a license. All these TRs meet the regulator’s requirements and their
(reporting) product is fairly standardised. This means that pricing becomes a
very important selection criterion. Most TRs charge a fixed monthly or a yearly
fee and a variable fee per reported derivative. Some of them charge maintenance
fees and/or give group discounts for reporting entities of the same group.
However, other very important factors to take into account when selecting a TR
are the available connectivity methods, the readiness of the testing
environment (a big bottle neck for TRs) and the implementation timelines
proposed by the TR.
After the TR is selected, a connectivity method
must be agreed between the market participant and the TR. The choice depends on
the volume to be reported and it is meant to be fully tested in the User
Acceptance Test environment provided by the TR. This entails getting the
required data from the treasury/risk management systems, creating the required
file and testing the (inbound and outbound) connections with the TR. The
implementation timelines vary for each TR and also depend on the chosen
Selecting and Implementing Central
When selecting a CCP, attention must be
focused on evaluating the following: the CCP’s margin collateral under
management, the size of the clearing fund, the safety mechanisms in the event
of defaults, the margin requirements, the fees (i.e. clearing member,
clearinghouse and execution fees). The selection of a clearing member and the
evaluation of the available connectivity methods and implementation timelines
are also very important. Some CCPs also offer other products, including
third-party valuation services and centralised collateral management, which
gives the option to market participants to outsource the execution of risk
mitigation techniques. Some CCPs also offer TR services. However, ESMA has made
clear that CCPs cannot force their clients to also use their TR services.
Neither reporting nor central clearing can be executed without treasury
and risk management systems that support these processes. In recent months,
system vendors have developed their products in order to support EMIR
compliance. At the moment, there are very few system vendors offering a product
that supports EMIR compliance with standard functionality (as opposed to custom
developments). Market participants need to ensure that their systems are
capable of the following: Firstly, calculate and report the clearing
thresholds. Secondly, execute central clearing with a CCP. Thirdly, report the
derivative details to a TR. Finally, support risk mitigation techniques
following best practices.
Best Practices in Risk Mitigation
The three risk mitigation techniques that are
always applicable to FCs, NFCs+ and NFCs- are timely confirmation, portfolio
reconciliation and dispute resolution. It is up to the organisations themselves
to decide whether or not portfolio compression is used as a fourth risk
mitigation technique. FCs and NFCs+ must also calculate the MTM of their
derivatives on a daily basis.
All risk mitigation techniques,
except for timely confirmation, are collateral management processes. Market
participants who don’t have these processes in place are enforced by EMIR to
start executing them for those derivatives that are not centrally cleared.
Those market participants who want to execute these risk mitigation techniques
following best practices need to have collateral management processes where
both non-system-related and system-related requirements are included.
Best practice in timely confirmation can be achieved by following, for
example, the principle of “one trade, one confirmation” and by using a system
which allows storing the electronic confirmation of each derivative. Examples
of best practices in portfolio reconciliation are defining the roles and
responsibilities across all relevant front, middle and back office areas
involved in the portfolio reconciliation, agreeing with the counterparties the
tolerances to determine what constitutes a significant mark-to-market
difference and having systems supporting the portfolio reconciliation.
Examples of best practices in dispute resolution are setting up
governance and/or escalation procedures to ensure proper senior management
visibility into collateral disputes and associated resolution activities and
having systems that allow investigating the source of a collateral dispute
after the portfolio reconciliation is completed.
mandatory under EMIR, portfolio compression (which consists in reducing the
number of trades in the portfolio without changing its risk profile) can also
be executed by following best practices by, for example, getting as many
dealers as possible to participate and executing compression cycles by
currency. The key role of systems in EMIR compliance is also seen when
calculating daily mark-to-market values per derivative. For example, MTM
calculations follow best practices if the system has the flexibility to apply
overnight index swap (OIS) discounting and cross-currency basis spread, assign
different yield curves for each derivative and take into account counterparty
credit risk in order to comply with IFRS13.
Time to Take
The time for seeing how other market participants
make a move towards EMIR compliance has now passed. The execution of risk
mitigation techniques should already be in place and the 12 February 2014
reporting deadline is looming. This leaves market participants with very tight
deadlines to become EMIR compliant. Have you already started taking action?
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