A recap of the key updates to the regime established by Regulation (EU) No 648/2012 of the European Parliament and of the Council of July 4, 2012 on OTC derivatives, central counterparties, and trade repositories (the European Market Infrastructure Regulation, EMIR) since our 2019 Regulatory Update.
Regulation (EU) No 2019/834 of the European Parliament and of the Council of May 20, 2019 (“EMIR Refit,” also known as “EMIR II”) amended many provisions of EMIR in order to streamline and reduce the burden of EMIR on derivatives counterparties. Key changes that arose as a result of EMIR Refit include:
- Financial counterparties. The EMIR definition of “financial counterparty” (FC) was expanded to include alternative investment funds (AIFs) established in the EU (even those with a non-EU manager) and central securities depositaries. This brought more entities within the scope of EMIR’s clearing requirements and margining provisions for non-cleared derivatives (NCDs). However, securitization special purpose entities and employee share purchase plans were excluded from the definition of an AIF—the result of industry lobbying—meaning that these entities are treated as non-financial counterparties (NFCs) for EMIR purposes.
- Thresholds for clearing and margining. EMIR Refit implemented clearing thresholds for FCs and NFCs: (i) FCs will be required to clear all asset classes if they exceed the clearing threshold for any asset class (and are required to follow margining rules regardless), while (ii) NFCs will only be required to clear asset classes for which they exceed the threshold (but are subject to margin obligations in all asset classes if they exceed the clearing threshold for any asset class). The calculation for threshold purposes is made by reference to the aggregate average month-end position in OTC derivatives contracts over the past 12 months.
- Removal of frontloading. Only contracts entered into after the clearing obligation took effect are required to be cleared under EMIR Refit. This provision aimed to ease the potential administrative burden on market participants at the time of introduction.
- Streamlined reporting requirements. These include (i) that an FC is solely responsible for reporting on behalf of a counterparty NFC where that NFC does not meet the clearing threshold (an “NFC-”), (ii) removing the obligation to report transactions entered into before 12 February 2014 (known as backloaded transactions), and (iii) removing the reporting requirement, in certain circumstances, for intragroup transactions where at least one party is an NFC.
- Trade Repository (TR) data reconciliation and access. The regulation also provided for (i) reconciliation of trade data between TRs, and (ii) access by non-EU regulators to EU TR data, where cooperation arrangements exist between ESMA and such non-EU regulators.
- FRANDT requirements. EMIR Refit also paved the way for an obligation to be placed on clearing members and clients providing clearing services (directly or indirectly) to provide those services on commercial terms which are fair, reasonable, non-discriminatory, and transparent (“FRANDT”). Following consultations by ESMA and the European Commission on how these standards should be implemented, FRANDT standards are to come into force on June 18, 2021.
- Power of suspension. EMIR Refit contains the power for ESMA to request that the European Commission suspend the clearing obligation for up to three months (renewable in three-month periods up to a total of 12 months), in respect of specific asset classes or types of counterparty, where necessary due to changes in clearing suitability or availability or to maintain financial stability.
- Insolvency risk. EMIR Refit amended Article 39 of EMIR to provide that Member States’ national insolvency laws should enable the assets of defaulting members and assets in client clearing accounts to be applied separately.
- Pension Scheme Arrangements. EMIR Refit also extended the clearing exemption enjoyed by pension schemes to June 18, 2021. A draft delegated regulation has been published proposing to extend this for another year.
Regulation (EU) No 2019/2099 of the European Parliament and of the Council of October 23, 2019 (“EMIR 2.2”) came into effect on January 1, 2020, and involved the categorization of all non-EU central counterparties (CCPs) into one of two categories, depending on ESMA’s determination of the level of a CCP’s systemic importance to the EU. CCPs in the non-systemically important category, Tier 1, continue to operate as usual. However, CCPs in the systemically important category, Tier 2, are now subject to stricter supervision requirements (including obligations to comply with requirements set by EU central banks). Additionally, as a last resort, if a non-EU Tier 2 CCP cannot be adequately supervised, ESMA and the Commission may require that it establish an entity in the EU and seek authorization from the relevant national competent authority to continue providing its services. Such a requirement could cause major changes to the business model of non-EU CCPs, particularly those currently established in the UK and U.S.
Margin Regulatory Technical Standards
Commission Delegated Regulation (EU) 2021/236 of December 21, 2020 (the “Margin RTS Amending Regulation”) was published in the Official Journal on February 17, 2021, amending the margin regulatory technical standards laid out in Commission Delegated Regulation (EU) No 2016/2251 of October 4, 2016 (the “Margin RTS”). The key points arising from this are set out below.
Delays to Initial Margin Requirements
On September 1, 2019, phase four of the initial margin (IM) rules for NCDs under the Margin RTS was implemented. This phase obliged counterparties to NCDs to exchange IM (subject to any available exemptions) where both counterparties (or their groups) each had an average aggregate notional amount (AANA) of NCDs above EUR 750billion, calculated across the last business day of March, April, and May in the year of implementation.
Under the Margin RTS, phase five, with an AANA threshold of EUR 8 billion, was due to come into effect on September 1, 2020. However, the threshold was increased to EUR 50 billion following industry pressure over the sheer number of groups that would be required to comply at once. Further, in April 2020, due to the coronavirus pandemic, the Basel Committee on Banking Supervision and the International Organization of Securities Commissions recommended that implementation of the final two phases be delayed a year. The Margin RTS Amending Regulation provides for a formal implementation of these recommendations, such that regulatory enforcement of phase five will be delayed until September 1, 2021. Phase six, using the original phase five AANA threshold of EUR 8 billion, will not be implemented until September 1, 2022.
FX Exemptions from Variation Margin Requirements
The Margin RTS Amending Regulation also (i) extends the duration of the exemption from collecting variation margin (VM) on physically settled FX forwards (which technically expired in 2018), and (ii) broadens this exemption to also cover physically settled FX swaps, in each case where one of the counterparties is not a MiFiD “credit institution,” “investment firm,” or third-country equivalent.
Temporary Exemptions for Both Initial Margin and Variation Margin Requirements
The Margin RTS Amending Regulation also contains an extension to the temporary exemption to collect IM and VM for (i) single-stock equity options and (ii) index options, lasting until January 4, 2024.
The Margin RTS Amending Regulation contains two key measures to mitigate the impact of Brexit. The first is the temporary expansion of the intragroup margin exemption to cover transactions between EU and third-country counterparties, lasting until June 30, 2022. The second is a “grandfathering” of margin requirements, meaning that where an NCD contract was entered into before the earlier of when the relevant margin requirements or Margin RTS Amending Regulation applied, the contract can be novated solely to replace a UK counterparty with an EU entity without the need to update legacy risk-management procedures. This measure is also time limited, meaning counterparties looking to take advantage of this provision can only novate between (i) January 1, 2021 and (ii) the later of (a) the date on which the relevant margin requirements apply and (b) January 1, 2022.
Clearing Regulatory Technical Standards
Commission Delegated Regulation (EU) 2021/237 of December 21, 2020 (the “Clearing RTS Amending Regulation”) was also published in the Official Journal on February 17, 2021, amending the technical standards concerning clearing of OTC derivatives in Commission Delegated Regulation (EU) Nos 2015/2205, 2016/592, and 2016/1178.
The Clearing RTS Amending Regulation contains two key amendments, mirroring the Brexit mitigations set out by the Margin RTS Amending Regulation above. The first is to extend the intragroup clearing exemption to cover transactions between EU and third-country entities until June 30, 2022. The second is to provide for a 12-month period of grandfathering of any clearing obligation exemption for legacy trades entered into before the introduction of this amendment where a contract is novated solely to replace a UK counterparty with an EU counterparty.
Benchmark Regulation Review – Grandfathering
As a result of the Benchmark Regulation Review, EMIR was further amended by Regulation 2021/168 of the European Parliament and of the Council of February 10, 2021. Similar to the Margin RTS Amending Regulation and Clearing RTS Amending Regulation amendments above, this amendment provides that NCDs entered into or novated before the date a clearing or margining obligation applied to them may be amended to replace a benchmark or introduce fallbacks without becoming subject to further margining or clearing procedures.
UK EMIR and Brexit
As of 11 p.m. on December 31, 2020, the Brexit implementation period concluded, and the EMIR regime ceased to apply directly in the UK. Instead, EMIR and related legislation were transposed into national law, as part of “retained EU law” under the European Union (Withdrawal) Act 2018 as amended. Amendments necessitated by this onshoring process were mostly made by:
- the Central Counterparties (Amendments etc., and Transitional Provision) (EU Exit) Regulations 2018;
- the Trade Repositories (Amendment and Transitional Provision) (EU Exit) Regulations 2018;
- the Over the Counter Derivatives, Central Counterparties and Trade Repositories (Amendment etc., and Transitional Provision) (EU Exit) Regulations 2019;
- the Over the Counter Derivatives, Central Counterparties and Trade Repositories (Amendment, etc., and Transitional Provision) (EU Exit) (No. 2) Regulations 2019 (the “Refit SI”); and
- the Over the Counter Derivatives, Central Counterparties and Trade Repositories (Amendment etc., and Transitional Provision) (EU Exit) Regulations 2020.
Associated technical standards were implemented as binding technical standards of the Bank of England, PRA, and FCA.
The net effect of this is that there is now a domestic form of the EMIR regime (“UK EMIR”), which is largely identical to that under EU law as in force at the end of the implementation period. However, the following key points should be noted as a result of the Brexit process:
- Governing bodies. Under UK EMIR, the UK Treasury now performs functions that were previously performed by the European Commission under EMIR. Similarly, the role of ESMA under EMIR has been split between the FCA and the Bank of England under UK EMIR. This has also led to certain provisions relating to fines, appeals, and other supervisory requirements being replaced with the relevant FSMA processes.
- Scope. UK EMIR is focused on UK counterparties, while third-country counterparties (and their UK branches) are largely outside its scope. This means that the relevant regime for EU counterparties will generally continue to be EMIR.
- Pending provisions not implemented. Only those provisions of the EMIR regime in force at the end of the implementation period became part of domestic law. This means that there could be significant divergence between the UK and EU regimes over time (e.g., with regards to the FRANDT requirements arising out of EMIR Refit). However, it is generally expected that the UK government will legislate to mirror EU developments in the context of the EMIR regime, at least in the short term. For example, the PRA and FCA recently opened a joint consultation into changes to the onshored Margin RTS that would largely echo the changes made by the Margin RTS Amending Regulation above.
- Impact on clearing and Central Counterparties (CCPs):
- UK clearing obligation. Derivatives subject to clearing under UK EMIR must be cleared through an FCA-authorized CCP, either established in the UK or a recognized third country. A temporary recognition regime has been implemented in the UK, under which substantially all EU CCPs and third-country CCPs recognized by ESMA have been recognized for up to three years until December 31, 2023. More generally, the Treasury has now announced an equivalence decision with regard to the EU supervisory regime for CCPs, and so, subject to cooperation arrangements being in place with the relevant national authority, EU CCPs will be able to apply for permanent recognition.
- EU clearing obligation. Derivatives subject to clearing under EMIR must be cleared through an ESMA-authorized CCP, either established in the EU or a recognized third country. On September 21, 2020, the European Commission published a determination that the UK’s framework for the supervision of CCPs is equivalent. In accordance with this decision, ESMA has recognized three UK CCPs (LCH Limited, ICE Clear Limited, and LME Clear Limited). However, this decision was time-limited, and will only last for 18 months until June 30, 2022. Following this, a permanent equivalence decision will be necessary to ensure continuity.
- Intragroup exemption. UK EMIR preserves the intragroup clearing exemption set out in EMIR. This is strengthened by the European Market Infrastructure Regulation (Article 13) Equivalence Directions 2020, under which the UK determines partial equivalence of each EEA State for the purposes of this intragroup exemption, opening the door to permanent applications for this exemption. The EU approach here is summarized in the section on the Clearing RTS Amending Regulation above.
- Pension Scheme Arrangements. It appears that, while there is a clearing exemption under UK EMIR for a transaction between a UK pension scheme and a UK FC, a transaction between a UK pension scheme and an EU FC may be subject to the EMIR clearing requirements, as the EMIR exemption currently only applies to EU pension schemes.
- Impact on reporting and TRs:
- UK reporting obligation. Transactions subject to UK EMIR must be reported to an FCA-registered, UK-established TR or recognized third-country TR. UK-based TRs with an ESMA registration were able to apply for a conversion in advance of the end of the implementation date. Further, a UK entity that is part of a group containing a TR registered under EMIR will be treated as if it were a TR for a temporary period (not exceeding three years from Brexit day), provided that it had submitted an advance application to the FCA.
- EU reporting obligation. Derivatives transactions subject to EMIR must be reported to an ESMA-registered, EU-established TR or recognized third-country TR.
- No cross-border reconciliation. Under UK EMIR, only FCA-authorized TRs are required to reconcile between themselves. Similarly, EMIR excludes all derivatives with a UK counterparty from the reconciliation process. Therefore, there will generally be no inter-TR reconciliation between UK and EU TRs.
- Authorities and access to data. There is currently no equivalence decision that would allow EU authorities to access UK EMIR data from TRs, or UK authorities to access EMIR data from TRs.
- Intragroup exemption. It should be possible for UK NFCs to rely on the intragroup reporting exemption where trading with an EU NFC in the same group, and vice versa. However, it is currently uncertain whether ESMA interprets this exemption as applying to all corporate structures, or only those with a parent organization in the EU, and so UK NFCs should be aware of this risk.
- Mandatory delegated reporting. As with EMIR Refit, the Refit SI provides for the mandatory transfer of the reporting duties under UK EMIR from NFC- entities to an FC with whom they are trading. However, NFC- entities in the UK should be mindful that, where they are trading with an EU FC who is not captured by UK EMIR, this transfer will no longer take effect, meaning UK NFC- entities will be responsible for reporting trades to a UK TR. The same applies for EU NFC-s trading with UK FCs. As such, NFC- entities may consider using an agreement, such as the Master Regulatory Reporting Agreement published by ISDA, to transfer reporting activities to a financial counterparty. However, this technically does not transfer the obligation to report itself, and so counterparties should ensure they adequately supervise the performance of any such agreement.
- Validation rules. UK trade repositories (TRs) and UK reporting counterparties should use an updated set of validation rules when submitting derivative transactions under UK EMIR.
- Impact on margining:
- Government securities. EU government debt securities as of March 31, 2022 will cease to be “eligible collateral” in the same way as UK government debt securities under UK EMIR, and will instead become subject to credit assessment.
- Intragroup exemption. Following the Treasury’s partial equivalence determination detailed above, UK entities will be able to apply to the FCA for permanent exemption. The EU position here is detailed in the section on the Margin RTS Amending Regulation above.
- Regulated markets. The Treasury announced on November 9, 2020 that UK firms may consider EEA trading venues as “regulated markets” under Article 2A of UK EMIR, confirming that the classification of transactions on these markets under UK EMIR is exchange-traded rather than OTC. However, the European Commission has not made a corresponding equivalence decision, meaning that at present, derivatives traded on a UK-regulated exchange are treated as OTC derivatives under EMIR. The effect of this is that the volume of OTC derivatives traded by an entity as calculated for EMIR purposes will be inflated by the amount of derivatives traded by that entity on a UK regulated exchange. This may cause that entity to exceed the EMIR clearing threshold. Counterparties under EMIR or UK EMIR will need to notify the relevant authority if they breach any clearing thresholds (or if they have chosen not to calculate their position) by June 18, 2021.
- Benchmarks. The FCA has confirmed that amending a reference rate or adding a fallback to legacy LIBOR trades will not trigger margining or clearing requirements under UK EMIR, but also reminded market participants that any such modification will still need to be reported to a trade repository. The FCA have given reassurance that their supervisory powers for this requirement will be applied in a proportionate and risk-based manner.
- Guidance. The FCA has confirmed that guidance published for EMIR remains relevant under UK EMIR to the extent applicable.
 https://www.esma.europa.eu/press-news/consultations/consultation-draft-technical-advice-commercial-terms-providing-clearing; and