New rules on initial and variation margin prepared by financial regulators would pose a serious threat to derivatives' OTC market liquidity.





Mandatory clearing on OTC derivative contracts along with the frontloading requirement deserve particular interest in the following months. 



Actions to be scheduled cover:

- analysing portfolios to identify contracts potentially subject to this requirement (taking account of their counterparties' statuses),

- carrying out the necessary calculations associated with the use of thresholds, 

- examinations whether the intragroup exemption from mandatory clearing could be applied under circumstances and whether its use is adequate to the company's business model,

- communications between counterparties whether they are subject to the mandatory clearing and the to the frontloading requirement,

- providing appropriate representations,

- amendments to the documentation of OTC derivatives contracts, 

- pricing models' adaptations, pricing recalculations to include the price of the frontloading in the contracts,

- implementing necessary arrangements for the frontloading to take place,

- making relevant changes to systems, controls and internal procedures to reflect these determinations and representations.


If the above analyses show the counterparty is within the scope of application of mandatory clearing, and, potentially, of the frontloading requirement, it will be necessary to arrange for the necessary clearing relationships.


The above process will have the iterative character, first come the IRS derivatives but the potential scope is much more extensive.


Read more on mandatory clearing...



Try our EMIR Clearing Thresholds Compliance Check!



ESMA latest EMIR Q&A October edition brings an important clarification on derivatives' reporting duties placed by the EMIR Regulation on the businesses relocated into the EU.


The EU financial authority explained the regulatory stance with regard to the following issue:


"Are third country entities (not subject to the reporting obligation when it came into force on 12 February), that have subsequently become financial counterparties in the EU (due to re-location or because they are managed by an AIFM which becomes authorised or registered under AIFMD), required to report trades that were entered into before they became subject to EMIR?"


So, the answer is:


"Yes. When a counterparty to a derivative contract that is outstanding establishes itself in the EU it becomes subject to the reporting obligation. This applies to all outstanding contracts, so that such counterparty's risks are known in the EU where that entity is now based. Non-reporting of those outstanding contracts would represent hidden risk that would be contrary to the EMIR / G20 reform objectives."


The logical implication is, before the relocation into the EU is effected due diligence process within the financial institution needs to  identify and establish whether there are any derivatives contracts outstanding and ensure they are reported to the trade repository within the required deadlines.


Read more on the EMIR reporting requirements...



The Commissioner Michel Barnier in his letter of 8 July 2014 addressed to ESMA referred to the issue highlighted in "EMIR frontloading - serious regulatory risk".


The key part of the EC letter explains that:


"The determination of remaining maturities should not result, in particular, in the application of the frontloading requirement to OTC derivatives concluded before counterparties could reasonably foresee that those contracts would need to be cleared as a consequence of the frontloading requirement. Such application could jeopardize the principle of legal certainty. In this respect, the Commission considers that before ESMA submits the RTS to the Commission, counterparties cannot reasonably foresee the terms of the frontloading obligation. Moreover, since the RTS may be amended or even rejected before they enter into force, some uncertainty may remain as to the concrete terms of the frontloading requirement until the delegated act adopting the RTS is finally published in the Official Journal."


So, I agree, legal certainty, and, what is evenly important, the viability of projected solutions, mustn't be omitted.


But what is practical and concrete effect of the above clarification? I'm still confused...




It needs to be recalled that positions taken by third-country non-financial entities in the same group as the non-financial counterparty, which would be non-financial counterparties if they were in the EU, count for the calculation of the EMIR clearing threshold.


Global conglomerates, EU-based subsidiaries thereof are relatively small, may be particularly affected.


ESMA in its EMIR Q&As update of 21 May 2014 (ESMA/2014/550) has underlined in this context that the group to which the non-financial counterparty belongs, includes subsidiaries, sisters and parent companies of the non-financial counterparty wherever the ultimate parent company is established. 


This clarification is rather obvious, however, its regulatory origin and rank removes any remaining ambiguities.


See more on the clearing threshold calculation under EMIR...




Frontloading - the term involved with EMIR Regulation should seriously worry derivatives players these days.



The manner in which the excess margin is dealt with by the clearing broker depends on whether the clearing client has an omnibus or individual client account.



Firms implementing re-use, re-pledge or re-hypothecation of initial margin as an essential component of their business models will have to reconsider strategies. Collateral transformation services may also be affected.



Pursuant to the draft RTS, depending on the assets' class, the concentration limits on initial and variation margins range from 10 to 50%. Non-financials below a clearing threshold shouldn't bother.



Industry master agreements differentiate between the "standard" dispute resolution procedure on the one hand and the process designed specifically for resolving EMIR-mandated issues on the other. What are their inter-dependencies?



EMIR cross-border issues (to be clear, the circumstances under which the EMIR clearing obligation, risk mitigation techniques and margin requirements apply to contracts between two non-EU entities) have been finally settled and published on 21 March 2014 in the Official Journal.


It is already known which guarantees in the extra-EU circulation are subject to EMIR rules.


See commentary on the issue.