Generally, a group of companies is often perceived by legislators and judicature as a single economic unit. The case is also present under EMIR rules, where for instance, to establish whether a subsidiary has crossed a clearing threshold, transactions of the entire group must be counted.
On the other hand, when a group - as a single economic unit - buys emission permits in the carbon market, the value of transaction is - for EMIR clearing threshold calculations - 300% of the trade.
It is evident that the monitoring of the EMIR requirements by non-financials mustn't consist in the verification of the clearing threshold levels only, but needs to be supported by sophisticated procedures and IT tools.
The threshold values above which the clearing obligation in relation to OTC derivatives applies is set under EMIR rules at a relatively high level (the exact values for each asset class see here), thus many may think that their trades are free from these regulatory requirements.
However, even the cursory overview of guidance being currently worked out by the European financial authority (ESMA) evidences multiple legal risk involved.
Among these potential threats there is also the fact that intra-group transactions must be counted against clearing thresholds, and, moreover, the European financial regulator adopted the stance that if two group entities having the character od non-financial counterparties enter into an intragroup transaction with each other, which does not fall within the hedging definition, both sides of the transaction should be counted towards the threshold. The total contribution to the group-level threshold calculation would therefore be twice the notional of the contract.
In the recent version of Q&A document of 5 August 2013 ESMA has also described the relations between intragroup companies and the corresponding external transactions, giving practical example As follows.
ESMA considered in particular the fact that in a group typically there is one, or more, company that is specialised in dealing in derivatives with entities outside the group. This trading company enters into external derivative contracts which, to the maximum possible extent, mirror one or more derivative contracts with entities within the group.
For the purpose of calculating positions to be compared to the clearing threshold, where the derivative contracts concluded by the group non-trading NFC qualify as hedging contracts, then the correspondent external contracts should also be considered as hedging contracts. On the contrary, where the derivative contracts concluded by the group non-trading NFC do not qualify as hedging contracts, then the correspondent external contracts should not be considered as hedging contracts either.
In the simplest scenario, whereby an external transaction perfectly mirrors a derivative contract concluded by a group non-trading NFC, which does not qualify as hedging contract, the counter value to be considered for the sake of calculating the clearing threshold amounts to three times the notional value of the intragroup or external transaction.
For illustration purpose, let us suppose that:
- A is a NFC
- B is a NFC in the same group as A, and B is the entity specialised in dealing derivatives with entities outside the group
- A and B enter into an OTC derivative transaction, with a notional value of 100, e.g. A buys 100 and B sells 100
- B enters into an opposite transaction with an entity outside the group (C), i.e. B buys 100 from C.
Then the total notional amount to be counted towards the clearing threshold pursuant to ESMA is:
- Zero, if the transaction between A and B satisfies the hedging conditions with respect to A;
- 300, if the transaction between A and B does not satisfy the hedging conditions with respect to A, i.e. 100 for the buy transaction between A and B, 100 for the sell transaction between B and A, and 100 for the buy transaction between B and C.
For me the logical measurement of the transaction where a group of companies, as a single economic unit, buys carbon permits in the market should be 100% and not 300%.