European Union Council adopts final EMIR 3 text

 Overview

EMIR 3 builds on the regulatory frameworks of EMIR 2.2 and EMIR REFIT by refining requirements for derivatives clearing, margining, and trade reporting. The regulation's primary goal is to enhance the EU’s financial stability and reduce reliance on non-EU CCPs, particularly those in the UK. It achieves this through mandatory compliance measures such as active account requirements (AAR) and a simplified methodology for clearing thresholds.

The publication of EMIR 3 in the Official Journal will mark the beginning of the development of critical technical standards necessary for its implementation. Key provisions of EMIR 3 require a substantial number of new Level 2 technical standards to be drafted by ESMA or the European Banking Authority (EBA) and subsequently adopted by the EU Commission. Although this process generally takes considerable time, it is understood that ESMA aims to prioritise and expedite the technical standards essential for central policy initiatives, such as the AAR (see below). Consultations on some of these technical standards could begin immediately following the publication of EMIR 3 in the Official Journal.

1. Active Account Requirement (AAR)

To encourage clearing through EU CCPs, EMIR 3 mandates entities exceeding clearing thresholds for systemically important derivatives to maintain active accounts with EU CCPs. These accounts must be operationally ready, with robust IT systems, legal documentation, and the capacity to handle volume surges. Exceptions apply for entities clearing at least 85% of their trades at EU CCPs.

Article 7a of EMIR requires certain FCs and NFCs to hold, for certain categories of derivative contracts, at least one active account at an EU CCP and for some of those Financial Counterparties (FCs) and Non-Financial Counterparties (NFCs) to clear at least a representative number of trades in this account. Specifically, Article 7a(1) of EMIR requires that counterparties hold active accounts at EU CCPs only where clearing services for the derivatives concerned are provided at one (or more) EU CCP(s).

The derivative contracts subject to the AAR as outlined in Article 7a(6) of EMIR and further clarified in Recital 11 of EMIR 3 are:

• Over-the-counter (OTC) interest rate derivatives denominated in euro;
• OTC interest rate derivatives denominated in Polish zloty; and
• Short-Term Interest Rate Derivatives (STIR) denominated in euro.

Key Changes introduced in EMIR 3:

[a] Threshold Determination

• EU entities within a group under EU consolidated supervision must calculate whether they exceed the threshold on a group basis (all relevant derivative contracts cleared by any entity within the group), excluding intra-group transactions.

• Entities clearing at least 85% of their systemically important derivatives through EU CCPs are exempt from the active account requirement.

The ESMA AAR consultation provides further clarification of the exclusion of intra-group transactions:

"As intragroup transactions are exempt from the AAR and can be used to replicate the desired risk exposures of the EU counterparty via back-to-back transactions with the third-country subsidiary, the recital further clarifies that ‘derivative contracts of third- country subsidiaries of Union groups should also be included to prevent those groups from moving their clearing activities outside the Union in order to avoid the active account requirement’. The recital also states that third-country entities that are not subject to the clearing obligation under Union law are not subject to the obligation to maintain an active account."

[b] Active Account Requirements

• An account is deemed active if it meets certain "operational conditions," including adequate IT connectivity, internal processes, legal documentation, and the ability to handle substantial volume increases at short notice.

• ESMA is tasked with drafting technical standards to define these operational conditions and mandate the annual stress-testing of compliance.

[c] Representativeness Obligation

• EU entities clearing systemically important products with volumes exceeding €6 billion must demonstrate that a "representative" amount of trades are cleared through EU CCPs.
• This generally involves clearing at least five trades in each of the most relevant sub-categories per product class, as defined by ESMA based on trade size and maturity.
• If this would account for more than half of the entity's total trades in the previous 12 months, the obligation is reduced to clearing at least one trade per sub-category per reference period.

[d] Reporting and Penalties

• Entities must report clearing volumes for systemically important products at EU CCPs and Tier 2 CCPs to national competent authorities (NCAs).
• NCAs are required to monitor compliance and impose penalties for non-compliance.

[e] Timing and Implementation

• Notification and Setup. Entities subject to the AAR must notify ESMA and their NCA and establish the account, meeting operational conditions, within six months of EMIR 3’s entry into force.
• Phase-In Period Concerns. While technical standards on operational conditions, representativeness, and reporting requirements may not be finalised within the six-month phase-in period, in-scope entities may still be expected to comply by that deadline.
• Clearing Threshold Assessment. Counterparties must assess applicability using the existing clearing threshold for interest rate derivatives, including STIR (exchange-traded products).

[f] Future Measures

• The Commission is empowered to introduce additional measures in subsequent years to address EU reliance on third-country CCPs, ensuring alignment with EMIR 3's overarching objectives.

2. Clearing Thresholds for NFCs

EMIR 3 simplifies the calculation methodology for NFCs, focusing solely on uncleared OTC derivatives. Under the current framework, thresholds for determining whether a NFC is classified as NFC+ or NFC- are calculated annually. This calculation includes the total value of all OTC derivatives, whether cleared or uncleared, but excludes derivatives used for hedging purposes.

Several issues arise from this methodology:

• Exchange-Traded Derivatives (ETDs). ETDs traded on venues not recognised as “equivalent” to EU venues (e.g., UK venues) are classified as OTC derivatives. This means they must be included in the calculation unless they are for hedging purposes, creating complications.
• Group Inclusion. Identifying all global entities within a group whose derivative positions must be included in the calculation can often be challenging to identify.

Key Changes Introduced by EMIR 3

[a] Simplified Scope. Only uncleared OTC derivatives will need to be included, excluding ETDs as long as they are cleared through a CCP authorised or recognised by ESMA. UK Venues are (somewhat oddly) not CCP recognised and thus are included in the overall OTC derivative threshold calculation (excluding any hedging exemption).

[b] Focus on NFC Transactions. Only transactions entered into by the NFC itself will count toward the threshold. Transactions can still be excluded as “hedging” if they mitigate risks related to activities of the NFC’s group.

[c] Revised Technical Standards. ESMA is mandated to draft new technical standards within 12 months of EMIR 3’s entry into force. These standards will specify updated clearing thresholds for different derivative classes and refine criteria for the hedging exemption based on market developments. ESMA will also conduct regular reviews of the clearing thresholds to ensure they remain fit for purpose.

[d] Timing and Implementation. The updated calculation methodology will take effect once the new technical standards on clearing thresholds are finalised and come into force. ESMA is mandated to draft, within 12 months from EMIR 3 coming into force, new technical standards specifying the clearing thresholds applicable to different classes of derivatives, taking account of the new calculation methodology.

 RegTrail Insights

Firms calculating their clearing thresholds under EMIR and operating in Europe will need to review and update internal EMIR clearing threshold calculations as noted above. Changes to the calculation may include:

Exclusion of ETD cleared transactions via an ESMA recognised CCP; and
Inclusion only for transactions entered into by the NFC while excluding hedging transactions (those transactions mitigating risks related to the activities of the NFC group).
Inclusion of all OTC derivative transactions from any UK venue that is not a recognised CCP in the EU.

Updated technical standards are a “known-unknown” and only until they are published will firms be able to adopt their current threshold calculations to fall within the revised EMIR 3 clearing threshold requirements. ISDA in a recent joint industry letter (click here for RegTrail's analysis) recommended that for Article 4a (i.e. the new clearing threshold calculation) given the requirements for the AAR and the new clearing threshold calculations are only separated by six months, that both provisions should come into force at the same time. Firms are evidently anxious about the requirement to implement the major requirements of EMIR 3 twice, first for Level 1 then later for the Level 2 RTS.

For those firms operating solely in the UK, the FCA issued a consultation on UK EMIR on 15 November 2024 (click here for RegTrail analysis) which outlines potential regulatory alignment but also potential reporting changes that would further complicate matters for firms operating in both UK and Europe. Specifically, there is a risk of regulatory divergence in the clearing threshold calculations and related regulatory reporting obligations, and the underlying data required to be captured and reported under the EU's EMIR 3 and UK EMIR.

For the time being, firms must ensure that they update their clearing thresholds to align to the updated final EMIR 3 text.

3. Collateral Accepted by CCPs in Respect of NFCs

EMIR 3 expands collateral options, allowing CCPs to accept public guarantees, commercial bank guarantees, and public bank guarantees under specific conditions. This change improves liquidity management for NFCs while ensuring compliance with exposure coverage requirements.

4. Clearing Thresholds for FCs

Under EMIR REFIT, a clearing obligation exemption was introduced for “small financial counterparties” (small FCs), defined as entities whose OTC derivative positions—calculated annually at the group level, with no exclusion for hedging contracts—did not exceed any of the clearing thresholds.

EMIR 3 amends this calculation methodology. FCs are subject to a two-limb test to determine their clearing obligations. This test differentiates between uncleared OTC derivatives and aggregate OTC positions, including those traded on non-equivalent venues, ensuring proportional application. Exemption only applies if both limbs (below) are met:

• First Limb. The FC calculates its positions in uncleared OTC derivatives at the group level to determine whether they exceed the clearing thresholds applicable to NFCs.
• Second Limb. If the thresholds for NFCs are not exceeded, the FC must then calculate its aggregate positions in all OTC derivatives (including cleared OTC derivatives and ETDs traded on non-equivalent venues) against separate clearing thresholds to be set by ESMA, which are expected to be higher.

The AAR Consultation reminds firms of the clearing threshold obligation and related calculations as follows:

"FCs and NFCs are subject to the clearing obligation when their aggregate month-end average position for the previous 12 months exceeds the clearing threshold specified pursuant to point (b) of Article 10(4) of EMIR (or where the counterparties do not calculate their positions).

Under Article 4a of EMIR, where a FC calculates its positions and the result of that calculation exceeds the clearing threshold, the FC becomes subject to the clearing obligation for all OTC derivative contracts pertaining to any class of OTC derivatives for which the clearing obligation is applicable.

Under Article 10 of EMIR, where an NFC calculates its positions and the result of that calculation exceeds the clearing thresholds, the NFC becomes subject to the clearing obligation only for the OTC derivative contracts in asset classes for which the result of the calculation exceeds the clearing thresholds. In addition, the NFC only needs to include the OTC derivative contracts which are not objectively measurable as reducing risks.

Article 5 of EMIR 3 clearly states that the changes to Article 4a and Article 10 of EMIR shall not apply until the entry into force of the RTS referred to in Article 10(4) of EMIR. In addition, ESMA notes that, according to Recital 9 of EMIR 3, the review is not expected to lead to substantial changes in order to ensure that the current prudent coverage of the clearing obligation is not affected by the new methodology.

Therefore, the clearing thresholds outlined in the current Commission Delegated Regulation (EU) No 149/2013 should be used for the AAR as from the entry into force of EMIR 3 as stipulated in Article 7a(1) of EMIR."

 RegTrail Insights

As noted in the AAR consultation, ESMA signposts that it does not intend to make substantial changes to the calculation of clearing thresholds which is a welcome gesture to firms who are cognizant of the additional IT and governance efforts required to augment data capture, calculation, and reporting when the threshold calculations are materially updated.

5. Transparency on Margin Requirements

CCPs are now required to provide initial margin simulation tools and disclose margin model details. Clearing members and clients must offer detailed margin-related information, ensuring better understanding and compliance.

6. Margining of Uncleared Derivatives

• Phase-in Period for NFCs. NFCs subject to margin requirements for the first time are granted a four-month phase-in period to establish operational arrangements.
• Substituted Compliance. EMIR 3 introduces amendments to Article 13, allowing the EU Commission to continue making equivalence decisions regarding the laws, regulations, and supervisory procedures of third countries. These decisions permit transactions with counterparties in those jurisdictions (and within the scope of the relevant decision) to be deemed compliant with the margin and risk-mitigation requirements outlined in Article 11 of EMIR. The existing requirement that a counterparty must be "established" in the relevant jurisdiction is replaced with a condition that the counterparty must be subject to the requirements deemed equivalent. This change benefits entities that operate under an equivalent ruleset but are formally established in a different jurisdiction.

7. Intra-group Exemptions

EMIR 3 simplifies intra-group transaction exemptions by eliminating the need for equivalence decisions with third-country affiliates. Instead, these transactions must meet anti-money laundering and tax compliance criteria.

Key Changes introduced in EMIR 3:

[a] Removal of Equivalence Requirement.

• The definition of an intra-group transaction under Article 3 of EMIR is amended to eliminate the need for an equivalence decision for transactions with affiliates in third countries.
• Instead, the exemption will apply provided the third country is not:

1. Listed on the EU’s anti-money laundering or terrorist financing blacklist; or
2. Identified as a jurisdiction involved in tax evasion.

[b] Discretionary Commission Power

• The EU Commission may, via delegated acts, prohibit intra-group exemptions for transactions with affiliates in specific countries if identified risks justify such a restriction.

[c] Timing and Implementation.

• These amendments take effect upon the entry into force of EMIR 3.
• Uncertainty remains regarding how these changes will interact with existing exemptions under transitional relief for transactions with affiliates in non-equivalent jurisdictions.

 RegTrail Insights

The removal of the equivalence requirement is a welcome simplification, but the lack of clarity on the transition from current exemptions creates potential uncertainty. Industry bodies are actively seeking guidance to address these concerns and ensure a smooth transition.

8. Reporting to Trade Repositories

Currently, groups that include NFCs with a non-financial parent company can apply for an exemption from reporting intra-group transactions. EMIR 3 introduces modifications to this exemption and makes additional changes to reporting requirements.

Key Changes introduced in EMIR 3:

[a] Modified Exemption for NFCs.

• Instead of removing the exemption as initially proposed, EMIR 3 modifies it:

1. NFC+ entities within a group that has an EU parent undertaking can still benefit from the exemption.
2. However, the parent undertaking must report the net aggregate positions by class of derivatives for that counterparty to its NCA on a weekly basis.

[b] Data Quality Requirements:

• Reporting entities must implement “appropriate procedures and arrangements” to ensure the quality of reported data.
• ESMA is mandated to issue guidelines on these requirements.
• It is unclear how this adds to the existing EMIR REFIT reporting technical standards and ESMA guidelines, which took effect on 29 April 2024.

[c] Penalties for Data Errors:

• Article 12 of EMIR introduces changes regarding penalties for breaches of reporting requirements.
• NCAs are required to impose penalties on entities whose reports contain systematic, manifest errors.
• The definition of “systematic manifest error” will be established through new technical standards drafted by ESMA.

[d] Timing and Implementation:

• No transitional provisions are included in the Level 1 text, raising concerns about how these new requirements interact with the existing reporting regime.
• Questions remain about the practical implementation of:

1. EU parent undertakings making reports to NCAs without a defined process.
2. NCAs imposing penalties for systematic manifest errors before ESMA defines the term.

[e] Industry Advocacy:

The industry has raised these issues with regulators, emphasizing the need for clarity on transitional arrangements and the timing of ESMA’s guidelines and technical standards. This clarity is critical to ensure smooth compliance with the updated reporting framework.