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What Is It About
Hot on the heels of EMIR REFIT, further changes to the EMIR regulation have been proposed by the European commission.
Why It's Important
Should the proposed changes be passed by the EU Parliament and Council in their current form, they will likely impact energy and commodity firms, and NFC firms in particular.
Key Takeaways
Key changes include amendments to rules on intragroup transactions, clearing obligation rule changes for financial and non-financial counterparties, further changes to reporting obligations and risk mitigation measures.
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Introduction
EMIR 3 – Considerations for Energy and Commodity Firms
Although RegTrail previously reported on the December 7th announcement by The European Commission on the Capital Markets Union Clearing Package (“CMU Clearing Package”), we review the announcement in further detail in this week’s ‘The One Thing’ given the potential implications to energy and commodity firms in relation to potential amendments to EMIR (so called “EMIR 3”).
The current EMIR review aims to increase the competitiveness of the European central clearing framework and encourage the transfer of more Euro clearing from the UK to EU Central Clearing Counterparties (CCPs) while also increasing the visibility of intragroup derivatives transactions and further improving the functioning of the overall EMIR framework.
There are six relevant points from the EMIR review proposal for energy and commodity firms to consider as follows:
- Obligation for financial and non-financial counterparties to have an active account with an EU CCP
- Obligation to provide information on clearing services
- Amendments to intragroup transactions
- Clearing obligation for financial and non-financial counterparties
- Changes to reporting obligation and risk mitigation measures
- Amending rules governing CCPs participation, margin and collateral requirements
Should the proposed changes successfully pass the EU Parliament and EU Council legislative process in their current form, some of the proposed changes will likely not be particularly well received by NFC firms.
We review the proposed changes and potential implications for energy and commodity firms in more detail.
Compliance Considerations
The CMU Clearing package includes a proposal for a review of the European Market Infrastructure Regulation (EMIR).
As a reminder, EMIR has been amended twice – by EMIR Refit and EMIR 2.2 – the latter of which revised the supervisory framework and set out a process for assessing the systemic nature of third-country central clearing counterparties (CCPs).
Morrison & Foerster, a law firm, provide a condensed summary (click here) of the European Commission’s (EC) proposal (click here for the proposal and here for the Q&A) regarding potential amendments to EMIR (so called “EMIR 3”) citing excessive reliance by EU firms on UK-based central clearing counterparties (CCPs) and stresses on “certain” energy firms making margin calls brought on by the EU Energy Crisis.
Despite the apparent focus of these changes on clearing and market infrastructure, there are a number of changes that impact some of the more "operational" aspects of EMIR that Compliance professionals should be aware of.
Six key relevant points for EU energy and commodity firms
[1] Obligation for financial and non-financial counterparties to have an active account with an EU CCP
- Obligation for financial and non-financial counterparties subject to the clearing obligation to have, directly or indirectly, an active account with an EU CCP and clear at least a proportion of such trades in the said EU CCP.
- Applies when a counterparty clears any of the following contracts: interest rate derivatives denominated in EUR and PLN, credit default swaps denominated in EUR and short-term interest rate derivatives denominated in EUR.
RegTrail Insight
Although most firms will not exceed the revised EMIR clearing threshold, those who do will need to review their clearing obligations and related clearing set up to ensure a portion of their derivatives that fall under this criterion are cleared via an EU CCP.
[2] Obligation to provide information on clearing services
- Where clearing members and clients provide clearing services both at the EU CCP and a recognised third-country CCP, they should provide information to their clients about the possibility of clearing the relevant contracts at the EU CCP.
- Clearing members and clients established in the EU or part of a group subject to consolidated supervision in the EU, and clearing in a recognised third-country CCP, will have to report to their national competent authority on the scope of their clearing activity in such CCP
[3] Amendments to intragroup transactions
- Proposal to delete Article 13 requirements that linked certain exemptions from intragroup clearing, reporting and risk mitigation requirements with the adoption of an equivalence decision by the Commission.
- In its place, proposal to implement a simpler framework with a list of jurisdictions for which an exemption should not be granted. The list will include countries that are deemed to be high risk due to having strategic deficiencies in their anti-money laundering/counter-terrorism financing regime and countries that are listed in Annex I of the EU list of non-cooperative jurisdictions for tax purposes.
RegTrail Insight
Should the amendment go forward, firms will need to review which legal entities fall under the ‘high risk’ jurisdiction and re-calculate EMIR clearing threshold positions. There is a higher probability of exceeding the EMIR threshold if a firm trades within legal entities that are based in ‘high risk’ jurisdictions. It is not clear whether the EU would place the UK on this list given the proposed provision appears to allow for arbitrary inclusion of countries on the list. Given however the EU's continued reluctance to grant 2a equivalence to the UK suggests that this is not beyond the bounds of possibility.
[4] Clearing obligation for financial and non-financial counterparties
- For Financial Counterparties (FCs), in respect of the calculation of thresholds towards the clearing obligation by financial counterparties, the Commission proposes that only derivative contracts that are not cleared at an EU CCP or a recognised third-country CCP should be included in that calculation;
- For Non-Financial Counterparties (NFCs):
- Proposal to mandate ESMA to review both the hedging exemption criteria (i.e. the criteria for establishing which OTC derivative contracts are objectively measurable as reducing risks), the level of thresholds above which the non-financial entities become subject to the clearing obligation, as well as to consider whether the current asset classes of OTC derivatives (interest rate, foreign exchange, credit and equity derivatives) remain accurate.
- Consider more granularity for commodity derivatives
- Only include derivative contracts that are not cleared at a CCP should be included in the position calculation towards overall EMIR threshold.
RegTrail Insight
For most firms that are NFCs, the potential change in the definition to hedging exemption criteria, specifically whether OTC derivative contracts are deemed as ‘reducing risk’ should raise eyebrows as this is the main lever used by most firms to remain under the EMIR threshold. In addition, the request to consider more granularity for commodity derivatives will be interesting given this may mean including wholesale energy products currently out of scope that fall under REMIT.
It would be a prudent exercise for firms to review their current REMIT positions (wholesale energy products) and re-calculate an EMIR threshold assuming all non-hedging positions are included to determine whether this would breach the EMIR threshold. The likely timing of the passing of this legislation is unclear, however there is recent precedent for rapid, substantial changes via such "reactive" legislative measures if the MiFID II "Quick Fix" changes are anything to go by.
[5] Changes to reporting obligation and risk mitigation measures
- Remove the existing exemption from the Article 9 EMIR reporting obligation that is applicable to transactions between counterparties within a group (i.e. intragroup transaction), where at least one of the counterparties is a non-financial counterparty.
- Amendments to Article 11 EMIR on risk mitigation measures, namely to ensure that NFCs that become subject for the first time to the obligation to exchange collateral for non-cleared OTC derivative contracts can benefit from an implementation period of 4 months in order to negotiate and test the arrangements to exchange collateral.
RegTrail Insight
Removing Article 9 EMIR reporting is an unwelcomed proposal given this exemption from intragroup reporting is a relatively recent development which most firms saw as the removal of an unnecessary burden. This might require firms to restart what they were already previously doing - this potential outcome should be planned for.
Further, should additional firms find themselves above the EMIR threshold and are required to clear, the implementation is proposed at 4 months which is not a long time to transition. Firms must review the potential implications of EMIR proposed changes and should there be a probability that the EMIR updates could increase EMIR thresholds, there should be a clear strategy and roadmap how to implement required changes from a trading and clearing perspective.
[6] Amending rules governing CCPs participation, margin and collateral requirements
- Where a CCP has on-boarded or intends to on-board non-financial counterparties as clearing members, that CCP should ensure that certain additional requirements on margin requirements and default funds are met.
- Includes a prohibition for non-financial entities to offer client clearing, with their participation being limited to keeping accounts at the CCP for assets and positions held for their own account.
- Amend provisions regarding eligible collateral so that bank guarantees and public guarantees are considered eligible as highly liquid collateral provided that they are unconditionally available upon request within the liquidation period.
RegTrail Insight
The proposed amendment will now make clearing on behalf of clients only available for FC entities. For those NFC firms who currently do offer clearing to customers, this amendment is a red flag to review and define an alternative strategy to adapt business model should the amendment pass.
In addition, the welcome of additional collateral for margining purposes is a positive development and aligns to the identical recent proposals by the European Commission to ensure firms who require posting of margin can use additional eligible collateral to meet those requirements.
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