Regulation on OTC derivatives central counterparties and trade repositories (EMIR)
Key Regulatory Technical Standards (RTS) adopted – the real work begins
EMIR entered into force on 16 August 2012 but obligations at that stage remained largely subject to further technical standards being drafted and adopted. The European Commission (EC) has now adopted various key RTS, in substantially the form proposed by ESMA, regarding the clearing and reporting obligations and OTC risk mitigation requirements (other than collateralisation). Assuming no objection from the European Parliament or Council, we currently expect to have these RTS becoming effective in mid/late March 2013 (on the understanding that the European Parliament will ask for a one-month extension to its review period). Market participants are therefore now in a position where implementation planning should be progressed in earnest. The following are some key aspects and timing considerations to note:
Timing of clearing obligation
It has become clear that the mandatory clearing obligation is now not likely to bite in practice on any class of standardised OTC derivatives until early 2014, once CCPs have become EMIR-authorised and relevant OTC derivatives cleared by those CCPs have been through a subsequent public consultation process run by ESMA.
Application of clearing obligation to existing transactions (frontloading)
It has also been clarified that the obligation, once the clearing obligation applies, will only look backwards to those OTC contracts concluded after the date when a relevant CCP becomes EMIRauthorised and ESMA then starts its consideration of the contract-type in question. This is likely to be no more than six months prior to the coming into force of the clearing obligation for any particular contract class. At one stage, there had been concerns that in some cases one might need to look back to any contracts concluded after transitional CCP notifications which were likely to take place in Q1 of 2013. So the priority for market participants in the short term is around OTC risk mitigation requirements (noting that collateralisation requirements are still awaited – see below).
Knowing your counterparty and OTC requirements
Since the extent EMIR obligations regarding OTC risk mitigation differ depending on the status of both parties to a trade, it will be important to know the EMIR categorisation of dealing counterparties so as to understand the compliance expectations applicable to each relationship.
The OTC risk mitigation requirements will cover the timeliness of agreeing trade confirmations, portfolio reconciliation processes, use of portfolio compression arrangements where appropriate, marking of positions to market/model and dispute resolution arrangements.
The process of categorising counterparties (which is necessary on an initial and ongoing basis), and the substantive obligations, will likely involve some repapering of existing OTC documentation.
It is anticipated that elements of this will be assisted by the availability of industry protocols or standard-form published wording where appropriate.
The EMIR reporting obligation applies to ALL derivative contracts outstanding on 16 August 2012 and those entered into on or after that date (ie exchange-traded and OTC derivatives).
However, the commencement of the obligation is tied to the date by which a recognised/registered trade repository is available. The earliest date any reporting can actually occur is currently set at 1 July 2013 (for interest rates and CDS, with other assets following), though that will move backwards commensurately if the process for registering a trade repository slips beyond 1 April 2012 (which we currently think is unlikely to be met).
The EC published a set of Frequently Asked Questions regarding EMIR at the end of 2012. These currently cover only a limited set of issues but there is scope for market participants to submit questions to the EC and it is expected that the FAQ document will be updated over time as regulators look to provide more clarity on particular issues.
Key RTS remain to be drafted
Resolution of the collateralisation requirements for OTC derivatives not cleared by a CCP is significantly delayed and consultation is now expected to be published in early 2013 (once other` consultations – in particular, the Basel consultation on margin requirements for non-centrally cleared derivatives – have completed). An additional paper is also awaited in relation to the extraterritorial application of EMIR following completion of discussions at an international level. Both of these papers will have potentially major structural impacts on the OTC market and will need to be considered carefully once available.
the priority for market participants in the short term is around OTC risk mitigation requirements.