European Market Infrastructure Regulation (EMIR)
The objective of the European Market Infrastructure Regulation (EMIR) is to mitigate the systemic risks inherent in the European derivatives market. EMIR gives rise to obligations for certain parties to derivative transactions. This also includes certain notifications to BaFin and ESMA.
What is EMIR?
Based on the experiences of the 2008 financial market crisis, the heads of state and government of the leading industrial nations at the 2009 G20 summit in Pittsburgh decided to increase the transparency and safety of OTC (over-the-counter) derivatives trading. The G20 leaders specifically decided that in future any standardised OTC derivatives would have to be cleared through central counterparties and that OTC derivatives must be reported to trade repositories.
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 (OJ L 201 dated 27 July 2012, p. 1) (European Market Infrastructure Regulation – EMIR) has been in force since August 2012 to implement these objectives and create a uniform supervisory framework regarding central counterparties (CCPs).
Who is affected?
The EU Regulation contains requirements for the parties to derivative transactions. Certain requirements apply irrespective of whether the entity concerned provides financial services or not. In this respect, the Regulation differentiates between so-called financial counterparties and non-financial counterparties. Pursuant to Article 2(8) of EMIR, a financial counterparty is defined as:
- any investment firm authorised in accordance with Directive 2004/39/EC;
- any credit institution authorised in accordance with Directive 2006/48/EC;
- any insurance undertaking authorised in accordance with Directive 73/239/EEC or any assurance undertaking authorised in accordance with Directive 2002/83/EC;
- any reinsurance undertaking authorised in accordance with Directive 2005/68/EC;
- any UCITS and, where relevant, its management company, authorised in accordance with Directive 2009/65/EC;
- any institution for occupational retirement provision within the meaning of Article 6(a) of Directive 2003/41/EC;
any alternative investment fund managed by alternative investment fund managers (AIFMs) authorised or registered in accordance with Directive 2011/61/EU.
For purposes of the Regulation, all other entities established in the EU are to be classified as non-financial counterparties (see also non-financial counterparties).
What is governed by the Regulation?
The Regulation contains the following elements in particular:
A clearing obligation has been introduced for standardised OTC derivatives. The clearing obligation applies to financial counterparties that are supervised in the European Union.
Non-financial counterparties are subject to the clearing obligation if they use derivatives on a larger scale and for purposes other than hedging the commercial risks associated with their business activity.
The contracting parties must comply with special risk-management requirements also in the case of transactions which, as a result of their structure, are not suitable for central clearing.
In order to increase transparency, derivative transactions must be reported to a trade repository. The EU Regulation also governs the requirements for the authorisation and continuous monitoring of central counterparties and provides for closer cooperation between the supervisory authorities. In addition, the responsibility for supervising the trade repositories is delegated to the European Securities and Markets Authority (ESMA). The provisions of the EU Regulation are directly applicable in Germany.
To which financial instruments does the Regulation apply?
OTC derivatives are derivatives within the meaning of Annex I, Section C, points (4) to (10) of Directive 2004/39/EU (Markets in Financial Instruments Directive – MiFID), which are not executed on a regulated market within the meaning of Article 4(1)(14) of Directive 2004/39/EC or on a third-country market considered equivalent to a regulated market in accordance with Article 19(6) of Directive 2004/39/EC. However, the requirement regarding reporting to trade repositories applies to all derivatives within the meaning of the aforementioned Directive.
For the time being, BaFin does not intend to apply Regulation (EU) 648/2012 (EMIR) prior to the implementation of Directive 2014/65/EU of the European Parliament and of the Council of 15 April 2014 on markets in financial instruments and amending Directive 2004/39/EC of the European Parliament and the Council (Markets in Financial Instruments Directive – MiFID II) to those contracts which will only subsequently have to be classified as derivatives pursuant to Annex I of Section C of MiFID II. This concerns derivatives on emission allowances in particular. Hence, Directive 2004/39/EC (MiFID) will, until MiFID II is transposed, continue to apply, subject to a different interpretation by ESMA.
What obligations must financial and non-financial counterparties comply with?
When the clearing obligation for certain groups of derivative contracts is imposed, subject to potential transitional periods, financial counterparties and non-financial counterparties whose OTC derivative volume exceeds a certain threshold are obliged to clear such OTC derivative contracts via a CCP.
To date, the following legal acts have been adopted by the Commission and have since come into legal force:
- Commission Delegated Regulation (EU) No 2205/2015 (OJ of 1 December 2015, L 314/18)
- Commission Delegated Regulation (EU) No 592/2016 (OJ of 19 April 2016, L 103/5)any credit institution authorised in accordance with Directive 2006/48/EC;
The regulatory technical standards (RTS) for imposing the clearing obligation for interest rate derivatives in the currencies NOK, SEK and POL are currently being drafted. The current status of consultations concerning the different derivative classes can be accessed on the ESMA website.
Moreover, non-financial counterparties have the obligation to monitor whether they are exceeding the clearing thresholds set out in EMIR and in the technical standards and are thus subject to the clearing obligation and further risk-management requirements regarding bilaterally traded contracts.
EMIR imposes special risk-management requirements regarding bilaterally traded OTC derivative contracts. The technical standards define these requirements in greater detail. In particular, the technical standards lay down the requirement that transactions in OTC derivatives be confirmed by the counterparties – preferably by electronic means – within a certain period.
Financial counterparties and non-financial counterparties that have exceeded the threshold referred to in Article 10 of EMIR must fulfil additional risk-management requirements. At a later date, this will also include the collateralisation of OTC derivatives that are not centrally cleared. Technical standards for these details will be adopted at a later date which will be in line with the joint standards of the International Organization of Securities Commissions (IOSCO) and the Basel Committee of Banking Supervision (BCBS) published on 2 September 2013.
Furthermore, financial counterparties and non-financial counterparties are required to report all transactions in derivatives (including exchange-traded derivatives) to trade repositories (see Reporting obligation ).
What action is required?
In order to ensure compliance with the new obligations, it may be necessary to adjust the contractual details of OTC derivative contracts.
Since 12 February 2014, counterparties have been required to report not only each new derivative contract but also all those derivative contracts which have existed since or existed after 16 August 2012.
In addition, since 15 March 2013, the risk-mitigation techniques laid out under Article 11 of EMIR must be applied to both new and existing contracts. These include the obligation to confirm in a timely manner and to regularly mark-to-market the derivative contracts, to reconcile and compress portfolios, and to resolve disputes.
Given that the obligations under EMIR extend to existing contracts, the contractual details for existing contractual relationships should also be adjusted.
BaFin believes that, in order for these obligations to be met, existing contractual agreements with banks and other counterparties should also be tested for compliance with the requirements set out by EMIR.
Please note that different entities have drafted special agreements for this purpose. If existing or future derivative contracts were entered into under an International Swaps and Derivatives Association (ISDA) Master Agreement, it is possible to sign a corresponding ISDA-EMIR protocol.
A special EMIR annex was developed for contracts entered into under the German Master Agreement.
BaFin recommends that counterparties consider signing these or other, including bilateral, agreements in order to meet the EMIR obligations.
Entities need a unique legal entity identifier (LEI) in order to fulfil the EMIR reporting obligation. Information on the identification of parties subject to the reporting obligation can be found under (see Reporting obligation ) "Reporting obligation". Entities which do not have a LEI yet should apply for their LEI immediately if they are subject to the reporting obligation of Article 9 of EMIR.
BaFin advises that contravention of the EMIR obligations is an administrative offence and may result in proceedings for the imposition of fines.