Mandatory clearing under EMIR: are you ready?
EMIR1 introduces a number of key obligations for counterparties in the derivatives market. Already in effect are the obligations to report to a trade repository and most of the risk mitigation requirements. Still to take effect are the two requirements seen by many as the most challenging: mandatory clearing and the mandatory exchange of margin for uncleared trades.
Mandatory clearing requires all relevant OTC derivatives contracts between in-scope counterparties that are entered into on or after the effective date for the clearing obligation for that counterparty pair (the Clearing Start Date) to be cleared through an authorised or recognised central counterparty (CCP), unless an exemption applies.
For the majority of market participants which are in a category subject to mandatory clearing and which are entering into transactions of a class subject to mandatory clearing, only new transactions entered into on or after the relevant Clearing Start Date will have to be cleared. However, some market participants will have to, from the relevant Clearing Start Date, clear relevant transactions entered into during a given period leading up to the relevant Clearing Start Date. This additional requirement is known as "frontloading".
The clearing and frontloading obligations will be phased in with the timing dependant on (a) the class of OTC derivatives contract, and (b) the categorisation of the counterparties to such contract.
EMIR prescribes that all EU financial counterparties (FCs) and EU non-financial counterparties which are above the clearing threshold (NFC+s) will be subject to the clearing obligation when they transact with another FC or NFC+, or a non-EU entity which would be classified as an FC or an NFC+, if it was established in the EU (in-scope counterparties).
Following the entry into force on 21 December 2015 of the delegated regulation (the IRS Clearing RTS) relating to the introduction of the mandatory clearing obligation for certain interest rate swap transactions in USD, EUR, GBP and JPY (G4 IRS Contracts), we now have a concrete timeframe for the first classes of transactions subject to mandatory clearing and frontloading. The IRS Clearing RTS includes a further categorisation of in-scope counterparties by splitting in-scope counterparty types into Category 1, 2, 3 and 4. This further categorisation impacts (a) whether the frontloading obligation applies, and (b) the relevan Date. It is, therefore, crucial for market participants to know both their own clearing categorisation and that of their counterparty.
The clearing obligation for this first wave of contracts will start from 21 June 2016 for Category 1 counterparties, 21 December 2016 for Category 2 counterparties, 21 June 2017 for Category 3 counterparties and 21 December 2018 for Category 4 counterparties. The frontloading obligation will apply (a) to G4 IRS Contracts entered into between FCs in Category 1 and Category 2 or their third country equivalents (so, it will not apply to NFC+s or FCs in Category 3), (b) to G4 IRS Contracts with a minimum remaining maturity of six months on the relevant Clearing Start Date, and (c) in respect of G4 IRS Contracts entered into from 21 February 2016 (for FCs in Category 1) and 21 May 2016 (for FCs in Category 2).
Further regulatory technical standards (RTS) relating to additional asset classes (including certain interest rate swaps in NOK, SEK and PLN, and certain index CDS) will be finalised in due course and are expected to be substantially similar in content. However, we do not yet have concrete timeframes in respect of these further asset classes.
To the extent they have not already done so, market participants that may be subject to the mandatory clearing and/or frontloading obligations should be actively taking steps to establish when the obligations will apply to them and what they need to do to comply. This will include classifying transactions and counterparties, confirming practices (for example, in respect of any future amendments to existing transactions) and negotiating and finalising the required documentation (such as client clearing addenda, frontloading termination rights and cleared derivatives execution agreements).
1. 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).