Financial Markets

The European Commission’s modifications to the European market infrastructure regulation [Emir] following a period of assessment has left many industry players unhappy over the short implementation timelines. By William Yonge, a partner at Morgan Lewis.

The European Commission has been studying the impact of Emir, which first entered into force on August 16, 2012, under its regulatory fitness and performance (Refit) programme. This has resulted in some targeted modifications, which came into effect on June 17, 2019, known as Emir 2.1. 

Controversially, some significant regulatory requirements emanating from the modifications wrought by the Emir Refit took effect immediately on June 17, a mere 20 days after the publication of the new legislation. The European Parliament's ECON Committee indicated in May 2018 that amendments under Emir Refit should take effect no sooner than five months after coming into force. The industry is unhappy that it was given just 20 days to meet the requirements flowing from the expanded definition of a financial counter-party (FC) and is lobbying for regulatory forbearance to be exercised by national regulators for a significant period.  The unexpectedly short period is ironic given Emir Refit was designed to reduce disproportionate burdens and to simplify Emir.

FCs under Emir [prior to Emir Refit] already include any EU or non-EU alternative investment funds (AIFs) managed by EU AIF managers (AIFM) authorised or registered under AIFM Directive [but not EU AIFs managed by non-EU AIFMs, which are typically classified as non-financial counter-parties (NFC), as well as EU banks, investment firms, Undertakings for Collective Investment in Transferable Securities (UCITS) and insurers.  Emir Refit extends the definition of an FC to add: i) any EU AIF irrespective of the location or status under AIFMD of its manager; and ii) a fund's AIFM if the AIFM is EU-established. Therefore, an EU AIF managed by a non-EU AIFM [which is currently classified as an NFC] will instead be an FC under Emir Refit. UCITS already constitute FCs under Emir.

The classification of an AIF as an FC or NFC is critical since it determines the application of certain Emir requirements, such as those relating to clearing and margin and other risk mitigation requirements.  EU counter-parties to AIFs, whether EU or non-EU, must therefore know what classification the AIFs fall into. An FC is under an obligation to centrally clear standardised over-the-counter (OTC) derivative contracts [subject to the new small financial counterparty (SFC) exemption described below] or perform risk mitigation procedures for uncleared OTC derivatives, for example the posting of margin, and trade reporting.  

Emir Refit helpfully recognises that FCs whose volume of trades falls below specified clearing thresholds qualify as SFCs and should not be subject to the clearing obligation at all, reflecting the disproportionate costs that smaller counter-parties would otherwise bear in order to meet the clearing obligation. The clearing thresholds for this purpose are the same as those under Emir that determine whether an NFC is an NFC – or NFC+, except that hedging transactions that an FC enters into must be included in the calculation. The extended scope of Emir is partially counterbalanced by the new SFC exemption, which will reduce the number of counter-parties needing to comply with the Emir clearing obligation. While SFCs are exempt from the clearing obligation, they remain subject to risk mitigation requirements such as those relating to margin, confirmation timings, and portfolio reconciliation and compression. 

Emir Refit removes the requirement under Emir that where the clearing obligation is triggered by an NFC for one asset class subject to the clearing obligation that is traded by it over the threshold, that obligation is triggered for all asset classes notwithstanding they are not traded by it over the threshold.  This welcome change will reduce the clearing burden on counter-parties who trade in clearable derivatives infrequently.

Irrespective of Emir Refit, Emir has an indirect impact on non-EU counter-parties such as AIFs.  Where an EU counter-party trades with a non-EU AIF, the clearing obligation and risk mitigation requirements for uncleared OTC derivatives already provide that the obligations of the EU counter-party are determined by reference to the equivalent categorisation of that non-EU AIF as if it were an EU AIF.  Accordingly, following Emir Refit, non-EU AIFs managed by non-EU AIFMs [who will not be directly covered by the expanded definition of an FC] will prima facie be categorised as equivalent to an FC – a third country FC. Non-EU AIFs may rely on the SFC exemption on the same deemed basis in order to be classified as equivalent to an SFC, a third country SFC.

The changes under Emir Refit should not of themselves cause a third country NFC – to qualify as an FC [as opposed to an SFC] and thereby become subject to the clearing obligation. However, Emir Refit does provide for delayed implementation for a non-EU AIF that has been re-classified as a third country entity FC and will have four months from June 17, 2019 to make clearing arrangements.

Finally, in a welcome de-regulatory development, Emir Refit abolishes the contentious back loading aspect of the trade reporting obligation so that parties will no longer be required to report derivative transactions that were not outstanding on February 12, 2014, the date that the trade reporting obligation under Emir commenced, and the front loading aspect of the clearing obligation.

A Speakers’ Corner is an area where open-air public speaking, debate and discussion are allowed. The original and most noted is in the north-east of Hyde Park in London

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