The Proposal for a Regulation of the European Parliament and of the Council on OTC derivatives, central counterparties and trade repositories (commonly referred to as the European Market Infrastructure Regulation - EMIR) provides for some new obligations envisioned to be imposed on non-financial counterparties (among others commodity firms) acting also on the emission market. The impacts are far-reaching and may require mayor organisational changes among market participants. There are also ambiguities regarding the practical implementation of the new measure.
The scope of the draft for a new legislative proposal being revealed by the Commission on 15 September 2010 (COM(2010) 484 final) is wide and lays down requirements covering all categories of OTC (traded over-the-counter) derivative contracts set out in Annex I Section C numbers (4) to (10) of the MiFID Directive (let’s remind that derivatives contracts relating to emission allowances are explicitly mentioned as financial instruments by point 10 of the Annex I Section C of the MiFID Directive).
The draft of the Regulation deals generally with financial counterparties, but there are a few exceptions. As the Commission stresses, leaving systemically relevant non-financial counterparties whose failure may have a significant negative effect on the market completely outside the scope of regulatory attention would not be an acceptable course of action, could lead to regulatory arbitrage and, finally, is necessary to ensure global convergence with third countries (mainly the US legislation). It seems that these exceptions should, however, be carved out carefully bearing in mind far less strict regulatory regime (in comparison with financial market legislation) applying to the non-financial counterparties.
Non-financial counterparties are generally covered by the new EMIR Regulation where certain thresholds (to be determined by the Commission in collaboration with the relevant authorities, including ESMA) are exceeded. Thresholds will be defined taking into account the systemic relevance of the sum of net positions and exposures by counterparty per class of derivatives. Specifying the thresholds will need to be tailored to the characteristics of the different markets, in case of energy markets for instance, there is envisioned cooperation between ESMA and the ACER (Agency for the Cooperation of Energy Regulators established by Regulation (EC) No 713/2009) in order to ensure that the particularities of the energy sector would be fully taken into account. The purpose of the thresholds is to identify systemically important positions in OTC derivatives taken by some non-financial counterparties.
Information and clearing thresholds
So, if the new Regulation materialises, commodity firms taking positions in OTC derivative contracts above information threshold will have to:
1) notify the competent authority,
2) provide justification for taking those positions,
3) report the details of any derivative contract they have entered into and any modification
thereof (including novation and termination) to a registered trade repository.
The draft further states that where a non-financial counterparty takes positions in OTC derivative contracts exceeding the clearing threshold it shall be subject to the clearing obligation with regard to all its eligible OTC derivative contracts.
The Regulation states in Article 7(4) that in calculating the positions for the clearing threshold OTC derivative contracts entered into by a non-financial counterparty that are ‘objectively measurable as directly linked to the commercial activity of that counterparty shall not be taken into account.’
It follows that for non-financial counterparties to be covered by the clearing obligations there are two prerequisites:
1) entry into a contract that isn’t ‘directly linked to the commercial activity’ of the counterparty,
2) clearing threshold exceeded.
As was observed in Explanatory Memorandum to the said legislative proposal, the clearing obligation will only apply to those OTC contracts of non-financial counterparties that are particularly active in the OTC derivatives market and if this is not a direct consequence of their commercial activity. For example, this may be the case for energy suppliers that sell future production, agricultural firms fixing the price at which they are going to sell their crops, airlines fixing the price of their future fuel purchases or any commercial companies that must legitimately hedge the risk arising from their specific activity.
Taking into account the wording of the draft of the Regulation, for the information threshold the character of the contract (commercial or speculative) is not relevant (Article 7(4) refers only to the paragraph 2 mentioning clearing threshold). Such a conclusion has also support in some parts of the Explanatory Memorandum.