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)
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
The ABBL organised on 21 March 2013 a conference dedicated to bring to light the stakes of the European Market Infrastructure Regulation (EMIR) for Luxembourg based financial actors.
The European Securities and Markets Authority (ESMA) has published a set of Questions and Answers in order to promote common supervisory approaches and practices in the application of EMIR across the European Union.
The ABBL would like to draw attention to recent developments in the US where it will become compulsory to use a LEI (Legal Entity Identifier) by April 10, 2013 to trade in certain derivatives instruments.
The ABBL would like to draw attention to recent developments in the US where it will become compulsory to use a LEI (Legal Entity Identifier) by April 10, 2013 to trade in certain derivatives instruments. This identifier will be used when an entity reports a transaction to a swap data repository, and under new CFTC (Commodity Futures Trading Commission) rules this LEI will be required. Although in a first instance this LEI concerns only the swap market in the US, the ABBL felt it was opportune to draw attention to this G20 / FSB initiative as it is likely to be also required for other types of transactions as well as in future EU regulations, at least for their reporting parts (EMIR, MIFID II, etc.).
The ABBL takes due note of the 3 consultation papers on Shadow Banking. The association would like to first warn that the concept of “shadow” does not necessarily mean that the activities are not regulated or supervised. The association has identified in many parts of these 3 dense documents areas that are either already regulated or will soon be regulated at EU level.
Since a surprise rarely comes alone, the same day the EU Commission published its draft level 2 regulation on AIFMD it also produced part of the level 2 measures on EMIR.
The good news about proposals to regulate shadow banking is that we are probably approaching the end of a long regulatory tunnel. An alternative view may be that the regulatory tsunami is slowly turning into a more ordinary wave of regulations. Indeed, the term “shadow”, although not very flattering for the industry, would suggest that regulators have addressed the body casting the shadow, as identified in the G20 regulatory agenda.
The 5th of August was the deadline for response to the ESMA consultation on EMIR level 2 measures. Several elements are to be taken out of this exercise, first of all given the high level of uncertainties at the time the mandate was given, it appears that ESMA has gone beyond some requirements of the level 1 text notably in trying to impose additional rules to clients of CCPs’ Members.
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