On 4 May the European Commission published a legislative text proposing changes to the current EMIR framework. Vice-President Valdis Dombrovskis, who presented the proposal, emphasised that the majority of the changes come as a result of the Commission’s call for evidence exercise which sought views from industry on where post-crisis legislation could be amended to streamline existing provisions and reduce effects of any unintended consequences. Below is an outline of the proposed Commission changes.
It should be noted that a Communication was published together with the EMIR review proposal which paves the way for a further legislative proposal which is expected to be published on 28 June. The Communication outlines challenges in the area of derivatives clearing and makes clear that further changes will be necessary to improve the current framework that ensures financial stability and supports the further development and deepening of the Capital Markets Union (CMU). Options under consideration include:
- Continued reliance on existing equivalence regimes
- Enhanced supervision of 3rd country CCPs for EU authorities
- Mandating that CCPs clearing a certain volume of euro-denominated products must be physically located within the European Union
Reporting of exchange traded derivatives
The proposal introduces single-sided reporting for exchange-traded derivatives transactions and assigns the reporting responsibility to clearinghouses.
Under the revised framework, the CCP is responsible, and legally liable, for reporting on behalf of both counterparties. The Commission has stated that this has the advantage that the reporting of ETDs will be greatly simplified without adversely impacting the transparency of the derivatives market. While the Commission accepts that CCPs will face a slightly higher burden, they are well equipped for this task and the overall reporting burden will decrease as the reporting requirement concerning ETDs will be eliminated for all other counterparties.
In addition, point (c) of Article 1(7) expands the mandate for ESMA to develop technical standards to allow for the further harmonisation of the reporting rules and requirements, in particular, the data standards, methods, and arrangements for reporting.
Removal of frontloading and backloading requirements
The obligation to report historic data ('backloading') is removed. The Commission believes that this will significantly reduce costs and burdens on counterparties and eliminate the potentially insurmountable obstacle of having to report data which may simply not be available without compromising prudential needs. At the same time, compared to the status quo, the change will result only in a very limited loss of data compared to the currently applicable rules.
In addition, the requirement to frontload is also removed. Point (b) of Article 1(2) removes the requirement laid down in EMIR to clear OTC derivative contracts entered into or novated on or after notification by a competent authority to ESMA on an authorisation of a CCP to clear a class of OTC derivatives but before the date from which the clearing obligation takes effect if the contracts have a remaining maturity higher than the minimum remaining maturity determined in a Commission Delegated Regulation on clearing obligations. In its 2015 report, ESMA supported the removal of frontloading requirements.
Intragroup transactions involving any non-financial counterparties are exempted from the reporting obligation. The Commission has justified this change by arguing that this has the advantage of significantly reducing the costs and burdens of reporting for those counterparties that are the most disproportionally affected by the requirement, while the very limited loss of data will not significantly affect authorities' ability to monitor systemic risk in the OTC derivative markets.
A dedicated recital on this issue points out that intragroup transactions involving non-financial counterparties represent a relatively small fraction of all OTC derivative transactions and are used primarily for internal hedging within groups. Those transactions, therefore, do not significantly contribute to systemic risk and interconnectedness, yet the obligation to report those transactions imposes important costs and burdens on non-financial counterparties.
Temporary suspension of the clearing obligation
Article 1(6) inserts to EMIR a new Article 6b that gives the Commission the power, on specific grounds, to temporarily suspend any clearing obligation on the basis of a request from ESMA and lays down the procedure for the suspension. As also pointed out by ESMA, this power is needed since in certain specific circumstances, continued application of the clearing obligation may be impossible (for example because the CCP(s) clearing the biggest portion of a certain OTC derivatives class may exit that market) or may have adverse effects for financial stability (for example because the clearing obligation would impede bilateral hedging for counterparties without access to the centrally cleared market). The new power is subject to tightly framed conditions, and the suspension would be limited in time.
The Commission’s impact assessment found that while there has been an increase in the share of OTC derivatives that are centrally cleared, there are a number of obstacles to access central clearing for certain market participants, and a need to introduce a mechanism to allow for the suspension of the clearing obligation on financial stability grounds. The Commission also points out that this new provision complements the proposed framework for the recovery and resolution of central counterparties by introducing the mechanism for a temporary suspension of clearing obligation in other situations than resolution.
In order to enable clearing members to gain predictability and to limit the tendency for CCPs to react in a pro-cyclical manner, CCPs are required to provide their members with simple tools allowing them to simulate the amount of collateral requested to clear future trades. Without revealing proprietary tools and patents, CCPs will make available a thorough description of their initial margin models to their clearing members for them to gain a clear understanding of their reach and their limitations.
Other proposed changes
Clearing obligation for non-financial counterparties: Contracts by non-financial firms above a clearing threshold will continue to have to be cleared through a CCP. However, the proposed amendments will allow firms to only clear those classes of derivatives which breach the clearing threshold. OTC derivatives used to hedge risks related to their activities continue to be subtracted from the firm's overall position and do not count towards the threshold set for the clearing obligation. In order to lower the operational burden for these firms and align the treatment of cleared and non-cleared derivatives, non-financial counterparties will now be required to assess their situation vis-à-vis the clearing obligation only once a year, based on the average activity over the months of March, April and May.
Clearing obligation for pension funds: Article 1(20) replaces the first subparagraph of paragraph 1 of EMIR Article 89 in order to extend by three years the temporary exemption from the clearing obligation of pension scheme arrangements, in the absence of a viable technical solution for the transfer by pension scheme arrangements of non-cash collateral as variation margins.
Clearing obligation for small financial counterparties: To increase incentives for clearing services to provide for smaller counterparties, the proposal requires that institutions offering clearing service do so under fair, reasonable and non-discriminatory (FRAND) commercial terms. Secondly, the proposal clarifies the interaction of the EMIR default management tools with insolvency laws by clarifying that assets and positions recorded in clients' accounts will not be considered to be part of the CCP's or clearing member's insolvency estate.