European Market Infrastructure Regulation (EMIR)
It is an European law that aims to reduce the risk posed to the financial system by derivative transactions. It impacts both the European and Non-European financial institutions and corporates. It impacts mainly in the following ways.
- Reporting of derivative trades to an authorised trade repository
- Clearing derivative trades above a certain threshold; and
- Mitigating of risks associated with derivative trades, for example, reconciling portfolios periodically and agreeing on dispute resolution.
EMIR is applicable to participants in the EEA Area (European Economic Area) and to the market participants outside the EEA trading with EEA counterparties.
Just like Dodd-Frank Act, EMIR has classified counterparties into two types, namely.
- Financial Counterparties (FC); and
- Non-Financial Counterparties (NFC)
Financial Counterparties (FC) include banks, investment managers, insurance companies or brokers. Non-Financial counterparites (NFC) include all entities which are not financial counterparties.
The non-financial counterparites are again sub-divided into two-forms depending on the position threshold, namely.
- Non-Financial Counterparty in Scope (NFC+)
- Non-Financial Counterparty out of scope (NFC-)
NFC+ counterparty is one whose rolling average position threshold over the 30 working days exceeds the regulatory threshold in any derivative class. NFC- counterparty is one whose rolling average position threshold over the 30 working days does not exceed the threshold in any derivative class.
The current thresholds of various asset classes under EMIR are as follows:
- Credit = EUR 1 billion
- Equity = EUR 1 billion
- Interest rates = EUR 3 billion
- Foreign exchange = EUR 3 billion
- Commodities and others = EUR 3 billion
The counterparties are required to report to ESMA through ESMA's website if the status of the counterparty has changed.
The Financial Counterparties (FC) and Non-Financial Counterparties in Scope (NFC+) have to clearly prescribed derivative trades through CCP. Non-Financial Counterparties out of Scope (NFC-) can clear bilaterally.
Some trades are required to be cleared through CCPs mandatorily irrespective of the location of the counterparties. For example,
- Non-EU entities trading through branches situated in EU; and
- Non-EU entities trading through qualifying guarantee from an EU financial counterparty covering its derivative activities.
Trade Reporting under EMIR
Reporting of trades to the Trade Repository is one of the main regulations under EMIR. The objective of this regulation is to provide regulatory authority with transparency in the derivatives market to facilitate identification and mitigation of systemic risk.
All derivatives trades (Exchange, Cleared OTC and OTC) need to be reprted to the Trade Repository. The Trade Repositories are entities regulated by ESMA.
Non-EEA counterparties need not report the trades to the Trade Repository. However, the counterparties of the EEA side need to report their trades.
The counterparties are required to generate, agree, and report Unique Trade Identifier (UTI) while reporting. The UTI will be used in clearing of trades as well. If the trade is executed on an electronic platform then the electronic platform shall generate the UTI. If the trade is executed bilaterally, then the parties must agree on the UTI. In case, one of the party is located in USA or if the execution platform is in USA, then as per the requirements under Dodd-Frank Act (DFA), Unique Swap Identifier (USI) shall be generated and the same shall be used for EMIR reporting.
All trades entered into after 16th August 2012 and still outstanding on the start date of reporting shall be reported. The start date for reporting is 12th February 2014. All trades entered into on or after 12th February 2014, irrespective of their outstanding status need to be reported. Any changes to the existing contracts (including confirmations), and early termination of contracts need to be reported as well.
The timeline for reporting is T+1 day.
How can reporting be done?
EEA counterparties are required to send two blocks of data electronically to the trade repository of its choice. The following are the two blocks of data.
- Counterparty data: This block of data includes items such as Counterparty's broker ID, Beneficiary ID, etc.
- Common data: This block of data includes items such as URI, Product ID, Notional Amount, Currency and other static data and economic data.
The counterparties need to also provide the Legal Entity Identifier (LEI) while reporting.
If one of the counterparty do not have the expertise or resouces to undertake trade reporting then it may delegate the responsibility of the reporting to the other counterparty. This process is known as "delegated reporting".
Risk Mitigation under EMIR
EMIR requires counterparties to apply stringent risk mitigation processes and techniques for un-cleared OTC derivative trades such as confirmation deadlines, portfolio reconciliation and compression, dispute resolution procedures, daily mark-to-market valuation, initial and variation margin, capital requirements, etc.
Timeline Confirmation
All counterparties should use electronic platforms or systems for trade confirmation. They should not use emails or other non-standard confirmation techniques. These rules are applicable both for Cleared and Uncleared OTC contracts. The following are the deadlines under EMIR for trade confirmations.
| Type of Counterparty |
Deadline for Confirmation |
| Financial Counterparties (FC) and Non-Financial Counterparties in Scope (NFC+) |
T+1 |
| Non-Financial Counterparties out of Scope (NFC-) |
T+2 |
Portfolio Reconciliation and Dispute Resolution
EMIR requires the counterparties of OTC derivatives to agree in writing on the arrangements under which the portfolios will be reconciled and also the mechanism for dispute resolution.
The frequency of reconciliation depends on the counterparty classification and the volume of outstanding OTC contracts. The following is the current prescribed frequency for portfolio reconciliation.
| Type of Counterparty |
Frequency of Reconciliation |
For FC and NFC+
Less than or equal to 50 contracts
More than 51 contracts and less than 500 contracts
More than 500 contracts
|
Once per quarter
Once per week
Everyday
|
For NFC-
Less than or equal to 100 contracts
More than 100 contracts
|
Once per year
Once per quarter |
Portfolio Compression
Portfolio Compression is recognized under EMIR as a mitigation technique for the purpose of reducing counterparty credit risk. The requirement of portfolio compression, under EMIR, depends on the counterparty classification and the number of outstanding contracts.
EMIR requires all types of counterparties (FC, NFC+ and NFC-) to have in place a procedure to perform, at least twice a year, a process to analyse the possibility to conduct a portfolio compression exercise.
As a norm, if the number of outstanding contracts are more than 500 then the parties should explore the possibility of portfolio compression at least twice a year (once in six months).
Mark to Market
FC and NFC- must undertake mark-market on a daily basis the value of the outstanding contracts. Mark-to-model can also be used in certain circumstances.
Initial and Variation Margin
If a product is not subject to clearing obligations (that means in case of bilateral OTC contracts), FCs and NFC+ are required to use Initial Margin and Variation Margin. NFC- may or may not use margining.
Capital Requirement
Financial counterparties will have to hold an appropriate and proportionate amount of capital to manage risk not covered by exchange of colalteral when trading an uncleared derivative product.
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