On 29 March 2012, the European Parliament adopted the final text of the Regulation for the European Market Infrastructure Regulation (EMIR), with the aim to introduce greater transparency and better risk management to the ‘over the counter’ (OTC) Derivatives market.
Concretely EMIR, which is expected to be applicable as of 1 January 2013, will introduce:
ii) common rules for central counterparties (CCPs),
iii) a reporting obligation for OTC derivatives,
iv) rules on the establishment of interoperability between CCPs,
v) the concept of data trade repositories.
EMIR has to be seen in a broader global context. In Pitsburgh in 2009, the G20 leaders committed to the implementation of strong measures to “improve transparency and regulatory oversight of [OTC] derivatives in an internationally consistent and non-discriminatory way.” In the US, the Dodd-Frank Act defines the OTC Derivatives market regulation.
The situation is slightly more complex in Europe. Besides EMIR, which focuses on the post-trade handling of OTC contracts, other aspects of OTC regulation also need to be simultaneously addressed, notably for the trading/negotiation side by MiFID 2 and the Market Abuse Directive.
Other more remote texts may also intervene in the debate, among them the Securities Law Directive, the Central Securities Depositaries Regulation, and of course the EU version of the Basel III Accord (CRD IV).
For the ABBL, it is of paramount importance to keep the broad picture in mind with all these changes in order to avoid certain redundant or conflicting requirements.
A derivative is a financial contract linked to the future value or status of the underlying to which it refers (e.g. the development of interest rates or of a currency value, or the possible bankruptcy of a debtor).
Over-the-Counter (OTC) derivative contracts are not traded on an exchange (for example the London Stock Exchange) but instead privately negotiated between two counterparts (for example a bank and a manufacturer). OTC derivatives account for almost 90% of the derivatives markets. In December 2009, the notional value of outstanding OTC derivatives was around $615 trillion or €435 trillion. The OTC derivatives market comprises a wide variety of product types across several asset classes (interest rates, credit, equity, foreign exchange (FX) and commodities) with widely differing characteristics and levels of standardisation. OTC derivatives are used in a variety of ways, including for purposes of hedging, investing, and speculating. Contrary to derivatives traded on exchanges, OTC derivatives are not automatically cleared through CCPs or subject to reporting rules.
A hypothetical example of hedging: a plane manufacturer has a contract to build 6 planes in the next 6 months and will need 10 tonnes of steel per plane. He may want to guarantee that whatever the fluctuations in the market of the price of steel, he gets steel at a certain fixed price for the next 6 months so as to be able to deliver the planes on budget. To cover for the risk of steel rising, the plane manufacturer could enter into an OTC contract with a bank for example. They could agree on a set price for a set quantity of steel for 6 months. If, after 6 months, when the contract matures, the market price turned out to be lower, the bank would make a profit; but if the market price turned out to be higher, then the plane manufacturer would be able to purchase the steel a price lower than the market price and thus save money.
(Source: European Commission)
A CCP is an entity that interposes itself between the two counterparties to a transaction, becoming the buyer to every seller and the seller to every buyer. A CCP's main purpose is to manage the risk that could arise if one counterparty is not able to make the required payments when they are due –i.e. defaults on the deal.
CCPs are commercial firms. There are currently about a dozen CCPs, all but one located in Europe or the USA, clearing interest rates, credit, equity and commodities OTC derivatives. There is currently no CCP clearing FX OTC derivatives.
(Source: European Commission)
A trade repository is a central data centre where details of derivatives transactions are reported.
Trade repositories are commercial firms. There are global trade repositories for credit, interest rate and equity OTC derivatives. Trioptima in Stockholm houses a global interest rate repository and DTCC Derivatives Repository Ltd in London houses a global equity derivatives repository and maintains global credit default swap data identical to that maintained in its New York based Trade Information Warehouse.
(Source: European Commission)
On the edge of the reporting obligation under EMIR ESMA found itself in a difficult position as to the status of FX Forward contracts: are they derivatives or not? The issue at stake is: shall these instruments be reported to a Trade Repository or not and, as a side issue, what is the definition of their status under MIFID rules?
The CSSF wishes to remind all concerned counterparties that as from 12 February 2014, they need to report details of any derivative contract (OTC or exchange traded) they have concluded, or which they have modified or terminated, to a registered or recognised Trade Repository (TR).
As the saying goes we are currently, from a regulatory point of view at least, living in interesting times, and today perhaps even more so than just few months ago. Financial institutions have been submerged by a tsunami of regulations, even though many of them have not yet reached the implementation phase. In fact, besides CRD IV, AIFMD, and in some interesting ways, EMIR, the rest is still in development phase.
The ESMA announced that the first trade repositories have been authorised under the European Market and Infrastructure Regulation (EMIR) on 7 November. As a result, any derivative counterparty in the European Economic Area (EEA) that is subject to EMIR, including corporates and other unregulated market participants, will be required to provide specific reports for transactions in all derivative asset classes (i.e. interest rates, foreign exchange, equity, credit and commodities) and for both over-the-counter (OTC) and exchange-traded derivatives.
ESMA published on 23 October 2013 an update of its Question and Answers (Q&A) on the European Markets Infrastructure Regulation (EMIR). This Q&A clarifies the use of Legal Entity Identifiers (LEI) for the purpose of trade reporting to trade repositories.
The ABBL responded to this consultation proposing that only the most actively traded instruments if fully standardised may be eligible. Foreign Exchange, just like in the US, and as currently proposed in the CPSS-IOSCO margin for non-centrally cleared OTC derivatives.
After a hot summer, weather-wise, it is likely that the last straight line to the end of the year will be hot as well, probably not in terms of temperatures, but from a regulatory perspective. Besides the imposing amount of work that still needs to be finalised in prudential regulatory matters, much work also lies ahead regarding securities and financial markets.
The CSSF wishes to remind all concerned entities of the obligations applicable to them under Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories (“EMIR”).
On 5 June 2013, the ABBL organised a short seminar for its members to discuss and present the impact of the Legal Entity Identifier (LEI), a new tool to help identify corporate actors on financial markets.
This document is intended to be continually edited and updated as and when new questions are re-ceived. The date on which each section was last amended is included for ease of reference
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