Tim Hartley speaks to Thomson Reuters on EMIR Refit

Commentary-TR-Tim EMIR Refit

Originally published by Thomson Reuters.

EMIR reforms: New EU reporting rules and proposed changes to CCP clearing

The 2008 financial crisis showed the desirability of intermediary central counterparties (CCPs) covering default and other derivative trade risks and collating details about all deals so regulators can spot potential market risks.

The 2012 European Market Infrastructure Regulation (EMIR) introduced the requisite rules. Its reporting requirements change substantially in 2024, and proposals for more fundamental reform, EMIR 3, have advanced.

EMIR applies to any EU-based entity that is a counterparty to a derivatives contract. It divides counterparties into financial counterparties (FCs), which are financial institutions, and non-financial counterparties (NFCs).

NFCs whose total positions in over-the-counter (OTC) derivatives exceed a qualifying threshold are essentially under the same, more onerous requirements as FCs.

EMIR contains a clearing obligation and a reporting obligation. The former obliges FCs and qualifying NFCs that are party to OTC derivatives contracts of a type designated by the European Securities and Markets Authority (ESMA) to use a CCP.

There are exemptions for certain intragroup transactions. The reporting obligation requires details of all derivative deals to be reported to a trade repository. These act as registries and provide collated information to relevant financial regulators.

EMIR refit

EMIR underwent a refit with regulation (EU) 2019/834. ESMA was mandated to draft new implementing technical standards (ITS) and regulatory technical standards (RTS) on the reporting obligation. These are the source of major changes that apply in the EU from April 29, 2024. Similar UK reforms apply from Sept. 30, 2024.

The reporting changes are designed to better align EMIR reporting with guidance on critical data elements set by the Committee on Payments and Market Infrastructures (CPMI) and the International Organisation of Securities Commissions (IOSCO).

The International Regulatory Oversight Committee (ROC) has overseen this harmonisation work since 2020.

The core change is a requirement for EMIR reports to use the ISO 20022 messaging standard XML methodology, already introduced for other reporting, including under the Securities Financing Transactions Regulation (SFTR).

The EMIR refit also introduces unique product identifiers (UPIs), and its overall aim is to improve data quality and compatibility. More details can be found here.

“By aligning reporting with the ROC’s critical data elements guidance, the EMIR Refit should produce more efficiency and efficacy by improving data quality, which has been lacking since EMIR reporting began,” said Tim Hartley, EMIR reporting director at Kaizen.

“A major benefit is that the Refit comes with more regulatory guidance than the current regime, including guidelines issued by ESMA last December that nicely back up the RTS and ITS by justifying and explaining many of their requirements.”

The ESMA guidelines span 329 pages and give firms copious information about their obligations, reducing the scope for disparate interpretations. Firms are dependent on ESMA Q&A documents, which many have found inadequate.

Burden for firms

Standardised reporting should prove a boon for firms, but moving to the new regime will not be easy. The number of reporting fields rises from 129 to 203, but this is not a straightforward increase. More fields must be reconcilable; some old fields are withdrawn, and many others are amended. Firms must also migrate live deals concluded under the old rules to the new format.

“There’s no avoiding the fact that the EMIR Refit will involve a lot of work,” Hartley said.

“Pre-existing live trades must be converted to the new format within six months, and the number of reconcilable fields rises from approximately 56 to 149 over time. But it is a good opportunity for firms, as they have better guidance and will be able to see whether the risk profile they’re giving regulators is fit for purpose.”

The main UK EMIR refit rules are in joint Bank of England- Financial Conduct Authority (FCA) policy statement PS23/2. The regulators said they tried to align with EU requirements as far as possible, but the UK will have 204 reportable fields, not 203, and the new rules take effect five months later.

“Except for their implementation dates, the EU and UK Refits are generally structured in the same way, with only minor differences, but we may see them diverge more with time,” Hartley said.

“Unlike ESMA, the FCA is covering tolerance levels in non-legally binding guidance, which it can change easily. Furthermore, the FCA will be issuing Refit Q&As periodically until around June 2024, and there’s potential for more divergence during that process.”

EMIR 3, proposed by the European Commission last December, would make major changes to EMIR’s clearing obligation. Its stated purpose is to reduce EU exposures to third country CCPs, meaning ones in the UK.

Bank for International Settlements figures show London still dominating global OTC FX and interest-rate derivative (IRD) clearing in 2022. The previous year, UK CCPs handled 94% of euro-denominated IRDs.

The EU sees this as a threat to its financial stability and autonomy and wants EU CCPs to replace UK ones, which have access to EU markets under a temporary equivalence determination.

Brussels hoped to end that determination in June 2022, but the deadline was extended to 2025, due to the lack of any adequate EU CCP. Meanwhile, a working group that included the European Central Bank (ECB) examined ways to end that weakness.

Controversial ‘active account’ requirement

EMIR 3 aims to encourage EU CCPs’ development by easing some regulatory requirements and boosting their market share with an “active account” requirement under new article 7a. This would require FCs and NFCs subject to the clearing obligation to clear an as yet unspecified proportion of deals through an EU CCP.

“There has been concern in the EU over the very high proportion of euro-denominated transactions cleared through London, especially by LCH,” said Kirsty McAllister-Jones, an expertise counsel at the law firm Ashurst’s global markets practice.

“The ECB says the proposed ‘active account’ requirement is necessary to improve financial stability, but it is only one of two arms of EMIR 3 aimed at reducing third country clearing,” McAllister-Jones said.

“The other is the introduction of measures that would make it easier for EU CCPs to expand their offering, including streamlining and clarifying the application process and related documentation requirements.”

The active account proposal has been controversial, especially as many firms want to keep a free choice of clearing venue.

The ECB’s official opinion on EMIR 3 endorsed it, subject to active accounts having an appropriate phasing-in period. Politicians were lobbied about the obligation, but the EU Parliament approved the proposal in its June report on EMIR 3 whilst recommending amendments.

“What the active account requirement will ultimately look like is very much up in the air,” McAllister-Jones said.

“The European Parliament has suggested softening the Commission’s proposals with a two-stage introduction, the second ‘quantitative’ stage only applying if an initial ‘qualitative’ one does not increase EU clearing. There is widespread concern about the requirement among market participants, who would like it to be as soft and unobtrusive as possible.”

The active account requirement is not the only controversial measure in EMIR 3. It contains several proposals intended to tidy existing rules, but they include scrapping the reporting exemption for intragroup transactions involving an NFC or third country equivalent.

“Some proposals are helpful, such as the suggestion that only transactions that are not cleared by an appropriate CCP should count towards the clearing threshold and giving NFCs that become subject to the margin requirements for the first time a four-month grace period to complete the necessary arrangements,” McAllister-Jones said.

“Others are less helpful, like removing the reporting exemption for intragroup transactions involving an NFC. The parliament picked up
on this and asked the Commission for an impact report and cost-benefit analysis of this proposal.”

(Tim Hitchcock, Regulatory Intelligence)