What is the EMIR REFIT?
Between May and August 2015, the European Commission (the Commission) carried out an extensive assessment of the European Market Infrastructure Regulation (EMIR). The review resulted in a report published in November 2016, in which the Commission concluded that, although there was no need for a fundamental change to the nature of the core requirements in EMIR, the legislation imposed disproportionate burdens and overly complex requirements on non-financial counterparties, small financial counterparties and pension funds.
As a result, EMIR was included within the Commission’s 2016 Regulatory Fitness and Performance (REFIT) programme which resulted, in May 2017, in a proposal from the Commission (the Commission Proposal) for a Regulation amending EMIR to address the issues it had identified. In June 2017, the Commission adopted a separate proposal to amend EMIR in relation to authorisation and recognition of CCPs. This Article will focus on the first proposal.
What is the current status of the EMIR REFIT?
Regulation (EU) 2019/834 of the European Parliament and of the Council (the "REFIT Regulation") was published in the Official Journal on 28 May 2019. The bulk of the provisions (subject to some exceptions as set out in "When does it apply?" below) will therefore apply from 17 June 2019 (20 days following publication).
What are the key changes to EMIR?
Definition of financial counterparty
The REFIT Regulation expands the definition of financial counterparty (FC) to capture EU AIFs (irrespective of the location of the AIFM) and, where relevant, their EU AIFMs, in addition to, as under the original definition, AIFs (irrespective of location) with an authorised or registered AIFM.
This will also has an impact on the EMIR classification of a non-EU AIF with a non-EU AIFM. Originally, such non-EU AIFs were classified as third country entities that would be non-financial counterparties if they were established in the EU (Hypothetical NFC). However, from 17 June 2019, non-EU AIFs with non-EU AIFMs will be re-classified as third country entities that would be financial counterparties if they were established in the EU (Hypothetical FCs). One of the key impacts of this re-classification is that such non-EU AIFs with non-EU AIFMs will become subject, on an indirect basis, to the EMIR margin requirements when trading with EU dealers. This is the case even if such non-EU AIFs with non-EU AIFMs had previously avoided the indirect application of those margin requirements by virtue of being a Hypothetical NFC that was below the clearing thresholds.
There are, however, new carve-outs from the definition of FC for UCITS and AIFs which are set up exclusively for the purpose of serving one or more employee share purchase plans.
Following comment and lobbying from the industry, an original proposal to capture securitisation special purpose vehicles has not been included in the definition of financial counterparty.
Small financial counterparty
The REFIT Regulation introduces a new concept of a “small financial counterparty” (SFC). An SFC will be exempted from the clearing obligation but, critically, will remain subject to the risk mitigation obligations, including the margin requirements.
The determination for whether an entity is an FC or an SFC will be made using the same clearing thresholds that apply to non-financial counterparties (NFCs)1. However, the determination would only need to be made once a year and would be based on the aggregate month-end average for the preceding 12 months. In light of ESMA’s statement issued in March 2019, this initial calculation must be made as of the day on which the REFIT Regulation enters into force. Therefore counterparties should be prepared to calculate their month-end positions, ending on 31 May 2019, with a view to having the results available on or before 17 June 2019.
However, the REFIT Regulation also permits an FC to dispense with the determination by essentially “opting up” to full FC status by a one-time notification to ESMA and its national competent authority (NCA) that it has not made the calculation.
An FC that exceeds the clearing threshold for at least one asset class or does not calculate its positions, would become subject to the clearing obligation in respect of in-scope products across all asset classes. The positions need to be calculated at the group level or, for UCITS and AIFs, at the level of the fund.
Determination of non-financial counterparty clearing threshold
As referred to above, the REFIT Regulation has replaced the 30-day rolling average determination of positions under the original EMIR of an NFC against the clearing thresholds with an annual determination. As for FCs, the initial calculation must be made as of 17 June 2019, although the carve out for transactions that are objectively measurable as reducing risk remain for NFCs.
The clearing regimes for FCs and NFC+s now differ, in that an NFC that exceeds the clearing threshold for one asset class must now only clear in-scope products in that particular asset class, rather than in respect of all asset classes (as was previously the case). However, an NFC that exceeds the clearing threshold for one asset class remains subject to the requirement to exchange collateral in respect of uncleared OTC derivative contracts in other asset classes.
As with FCs, the REFIT Regulation permits an NFC to “opt up” to NFC+ status by sending a one-time notification that it has not performed the calculation, in which case it will be subject to the clearing obligation in all asset classes.
Since inception, the requirements of the reporting obligation have been among the most problematic and contentious of EMIR. Whilst steadfastly retaining the concept of two-sided reporting, the REFIT Regulation contains some more minor concessions in this regard:
- Reporting by NFC-s: where an FC has entered into derivative transactions with an NFC that is below the clearing threshold (NFC-), then the FC will be solely responsible for reporting on behalf of both parties. The EMIR REFIT provides some additional protection for FCs in respect of this new obligation, by requiring the relevant NFC- to provide relevant information.
Similarly, an NFC- will not be required to report its derivative transactions with a third country counterparty that would be an FC if established in the EU as long as third country reporting regime has been deemed equivalent and the third country FC has reported these transactions.
However, an NFC- that has already set up a reporting arrangement has the option to choose to continue to report their derivative contracts with an FC. They are expected to inform the FC of their decision beforehand.
- Intragroup Transactions: the REFIT Regulation also removes the reporting obligation for intra-group trades, where at least one of the counterparties is (or would be, if it were established in the EU) an NFC. However, to be able to apply this exemption, both counterparties must be part of the same group and their parent undertaking cannot be an FC. Also, they both need to be subject to centralised risk evaluation and control procedures and they will need to notify their national competent authority of their intention to apply the exemption.
- Backloading: Thirdly, the REFIT Regulation removes the previous obligation to report historic derivative transactions which were no longer outstanding on the original reporting start date (12 February 2014), but which were outstanding on or entered into after the entry into force of EMIR (16 August 2012).
The technical deadline for reporting historic trades was 12 February 2019 - prior to the REFIT Regulation entering into force. Therefore, ESMA, in its January 2019 statement, confirmed that, during the timing gap, it expects NCAs “not to prioritise” their supervisory actions towards counterparties’ reporting of backloaded transactions.
- Automatic Delegation: the REFIT Regulation adopts a provision from the Securities Financing Transaction Regulation, by providing for an “automatic delegation” of the reporting obligation:
- to UCITS management companies in respect of derivative transactions entered into by the relevant UCITS; and
- to AIFMs in respect of derivative transactions entered into by the relevant AIFs.
There was some discussion in the drafting of the REFIT Regulation about CCPs being responsible for reporting exchange traded derivatives on behalf of all parties. However, the final text merely imposes a requirement on the Commission to review the reporting of exchange traded derivatives within 18 months of entering into force of the REFIT Regulation.
Removal of frontloading obligation
The REFIT Regulation has removed the requirement to clear contracts which had been entered into (or novated) before the clearing obligation took effect, provided the contracts were entered into after a specified date and had a remaining maturity which is higher than a minimum specified by the Commission when introducing the clearing obligation.
FRANDT (Fair, Reasonable, Non-Discriminatory and Transparent commercial terms)
The REFIT Regulation introduces an obligation on clearing brokers to provide services on fair, reasonable, non-discriminatory and transparent commercial terms (FRANDT), with further detail to be set out in a Commission delegated act. This provision builds on existing requirements in EMIR and MiFID2, but confers considerable discretion on the Commission and hence creates uncertainty as to what it will ultimately involve.
The REFIT Regulation specifies a range of factors on which FRANDT requirements will be based, for example fairness and transparency on fees, and reasonable commercial terms to ensure unbiased and rational contractual arrangements. In addition, clearing members and their clients will be required to take reasonable steps to manage conflicts of interest so clearing services provided on FRANDT terms are not adversely affected. The REFIT Regulation also makes it clear that there is no requirement to provide clearing services and that brokers are permitted to control the risks associated with the services they offer.
Power to suspend the clearing obligation
The REFIT Regulation gives the Commission the power to suspend the clearing obligation for three months, extendable for successive periods of three months up to a total of twelve months, for specific classes of OTC derivatives or a specified type of counterparty. This power would be triggered by a request from ESMA and be exercisable in certain prescribed circumstances, for example that the only CCP able to clear those derivatives is likely to cease trading. Any such suspension would be extended to the trading obligation in MiFIR.
Extension of pension scheme clearing exemption
The final transitional exemption for pension scheme arrangements from the clearing obligation in respect of certain OTC derivatives expired on 16 August 2018. The REFIT Regulation extends this for a further two years and empowers the Commission to extend it thereafter twice by one year.
The expired exemption will be retroactively applied to derivative contracts entered into by pension scheme arrangements between 17 August 2018 and the date on which the REFIT Regulation will enter into force.
To avoid potential challenges that pension scheme arrangements could face clearing their OTC derivative contracts between 17 August 2018 and the day on which the REFIT Regulation comes into force, the Financial Conduct Authority (FCA), following ESMA’s statement issued on 03 July 2018, confirmed that it would not require pension scheme arrangements and their counterparties to clear derivatives.
ESMA has clarified in its Q&As that pension funds benefitting from the temporary exemption do not need to calculate their positions or notify ESMA and their NCAs.
Segregation of positions and assets by clearing members and CCPs
EMIR already requires CCPs to keep records and accounts that distinguish their own assets from the assets of each of their clearing members. Furthermore, clearing members must keep records and accounts that distinguish their own assets from assets held for the account of their clients.
The REFIT Regulation requires only that national insolvency law does not prevent the CCP from complying with its existing EMIR obligations in respect of porting and liquidation of accounts.
The REFIT Regulation mandates the Commission to adopt draft regulatory technical standards with regard to supervisory procedures to ensure initial and ongoing validation of the risk management procedures that require the timely, accurate and appropriately segregated exchange of collateral. The European Banking Authority (EBA), in cooperation with the other European Supervisory Authorities (ESAs), has 12 months from coming into force of the REFIT Regulation to develop draft regulatory technical standards, so it is too early yet to say what the supervisory procedures will require.
However, a recital to the REFIT Regulation clarifies that this requirement is intended to avoid inconsistencies across the EU arising out of the complexity of risk management procedures involving the use of internal models, and as a result such procedures must be validated by regulators before they are applied. This provision is currently being interpreted as introducing a requirement for initial margin models to be approved, both on initial use and on an ongoing basis. This would include the ISDA SIMM. We understand this is currently the subject of advocacy from certain industry bodies.
What about FX transactions?
Probably in light of the separate workstream of the European Supervisory Authorities (ESAs) to amend the margin regulatory technical standards to provide for an exemption for physically-settled FX forwards from the requirement to exchange variation margin other than between the most systemic counterparties (ie credit institutions and investment firms), the REFIT Regulation does not contain any substantial provisions in this regard, but suggests that an exemption should be made and that physically-settled FX swaps should also be exempted on the same terms.
When does it apply?
Most of the REFIT Regulation comes into force on 17 June 2019, however, the application dates for some requirements are delayed to allow counterparties time to prepare. These include:
|Amendments to national insolvency law
||+ 6 months
||18 December 2019
|Obligation on CCPs to provide initial margin information to clearing members.
||+ 6 months
||18 December 2019
|“Auto-delegation” of reporting to FCs (if NFC- counterparty) and to AIFM or UCITS Manco.
||+ 12 months
||18 June 2020
|Validation of risk mitigation procedures
||+ 12 months (but depends on RTS)
||June 2020 (but depends on RTS)
||+ 24 months
||18 June 2021
What should you be doing about the REFIT Regulation?
Although the REFIT Regulation contains some phase-in periods, these are relatively limited in nature. In particular, the changes to the definition of financial counterparty and the requirement to determine aggregate positions apply from 17 June 2019.
Some of the changes discussed above will require existing processes to be updated, new processes to be established, and fresh client/counterparty outreaches. The experience of implementing EMIR has demonstrated that these will require a significant amount of lead time, so our suggestion is that firms commence their planning earlier rather than later.
1 ie €1bn for each of Credit and Equity and €3bn for each of Interest Rate, FX, and Commodity and other.
This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.