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EMIR – one step closer to clearing

On 18 December 2014, the European Commission (the EC) published a revised draft of the regulatory technical standards (in respect of certain interest rate swaps) on the clearing obligation (the IRS RTS) pursuant to Article 5 of EMIR.1

In summary, the EC intends to endorse with amendments the draft IRS RTS previously submitted by ESMA to the EC.2 The EC’s amendments tackle issues on frontloading and counterparty categorisation which arose in the version of the IRS RTS submitted by ESMA.

Postponing the start date of the frontloading requirement

“Frontloading” has been particularly contentious as it requires counterparties to retrospectively clear certain transactions on the date the clearing obligation takes effect. In other words, to clear transactions entered into before the mandatory clearing obligation actually takes effect even where those transactions have been entered into on an uncleared basis and priced accordingly. Although ESMA’s draft of the IRS RTS placed some limitations on the scope of frontloading (both in terms of counterparties subject to the obligation (see below) and relevant transactions) the EC has postponedthe start date of the frontloading period to help ensure counterparties can determine whether they are subject to frontloading and implement the necessary arrangements for frontloading to take place.

Category 1 counterparties: Frontloading will not start until two months following the entry into force of the IRS RTS. The EC states that the delay is to give Category 1 counterparties sufficient time to establish whether they can benefit from the intragroup exemption for certain intragroup transactions.

Financial counterparties in Category 2: Frontloading will not start until five months following the entry into force of the IRS RTS. The delay is intended to give financial counterparties (other than those in Category 1) sufficient time to establish whether they reach the Category 2 threshold3 and, therefore, whether they are subject to frontloading.

Category 3 counterparties and non-financial counterparties (regardless of categorisation) are not subject to any frontloading.

Despite the helpful delay to the beginning of the frontloading period, there are still concerns over identifying which entities will be subject to frontloading (see below) and the timeframe for implementation.

Category 2/Category 3 classification

The Category 2/Category 3 distinction is important, both for determining the start date for the clearing obligation and whether frontloading applies. Under the previous iteration of the IRS RTS, the period for determining whether a financial counterparty or AIF has reached the Category 2 threshold was three months before the IRS RTS entered into force, something which created issues in terms of retroactive application of legal obligations. The EC has recommended removing this legal uncertainty by amending the Category 2 calculation period to three months following the publication of the IRS RTS in the Official Journal (excluding the month of publication).

The EC has also proposed that a recital should be included which clarifies that for investment funds, the Category 2 threshold should be calculated per single fund rather than at group level, provided that in the event of fund insolvency, the funds are distinct legal entities that are not collateralised, guaranteed or supported by other investment funds or the investment advisor itself.

However, challenges remain in respect of Category 2/Category 3 classification: the definition of “group” is complex and difficult to apply; entities that would be in Category 2 or Category 3 need to establish processes to collect the relevant data within a short timeframe; and notification of categorisation (including understanding the level of reliance an entity can place upon a notification) needs to occur. Although the frontloading window has been delayed to mitigate these issues (see above), counterparties have a lot to do within a short timeframe.

Excluding non-EU intragroup transactions from the scope of the clearing obligation

EMIR excludes certain intragroup transactions from the clearing obligation. However, where the intragroup transaction is between an EU entity and a third country entity, the intragroup exemption cannot apply until an “equivalence” decision has been made in respect of that third country. We do not yet have any “equivalence” decisions and, while timing is uncertain, it is very unlikely any “equivalence” decisions will be made before the first clearing obligation comes into force, particularly if frontloading is taken into account. This would mean transactions between EU and third country group members would be subject to clearing, while transactions between EU group members may be exempt. The EC has removed this discrepancy by providing transitional relief whichdeems equivalence to have occurred for this purpose for a period of up to the earlier of three years following the entry into force of the IRS RTS or until an equivalence decision is made for the relevant third country. This allows an EU and third country group member to apply for and use the intra-group exemption in the interim.

Next steps

There is some uncertainty over the timeframe for the IRS RTS to enter into force. However, the EC’s revised draft of the IRS RTS has certainly brought Europe one step closer towards mandatory clearing, and industry expectation is that the IRS RTS could come into force by May 2015. We expect that once the EU authorities have finalised the IRS RTS, regulatory technical standards applying the clearing obligation to other asset classes will swiftly follow. In preparation, market participants should now: consider their counterparty categorisation (and the steps they will need to take to make such determinations); prepare to communicate their categorisation with their counterparties (including notifying any third country entities that will need to collect data and confirm their categorisation); review the application of any exemptions; and put in place their clearing documentation, such as client clearing agreements.


1. The European Securities and Markets Authority's (ESMA) Final Report: Draft Technical Standards on the Clearing Obligation – Interest Rate OTC Derivatives (1 October 2014).
2. Where the entity belongs to a group whose aggregate month-end average of outstanding gross notional amount of non-centrally cleared derivatives over the three-month period following the publication of the IRS RTS is above EUR 8 billion.
3. 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.

Legal and Regulatory Risk Note