As opposite to OTC derivative contracts between EU branches of non-equivalent third countries (which are proposed by ESMA to be subjected to EMIR) OTC derivative contracts between the EU branch of a non-EU entity and another non-EU entity is not captured. Such an approach seems to be lacking in systemic cohesion.



Given the additional operational burden EMIR imposes on counterparties trading OTC in emission derivatives (obligation to centrally clear OTC derivative contracts or to apply risk mitigation techniques), and the global nature of emissions derivatives market, the key aspect is to establish the territorial scope of EMIR requirements.


The primary rules – currently at the draft stages (ESMA Consultation Paper Draft Regulatory Technical Standards on contracts having a direct, substantial and foreseeable effect within the Union and non-evasion of provisions of EMIR of 17 July 2013, ESMA/2013/892) are proposed as follows:


1. EMIR obligations apply to OTC derivative contracts when counterparties are established in the Union.


2. When one counterparty is established in the Union and the other counterparty is established in a third country (cross-border transaction), the clearing obligation or risk mitigation requirements would apply subject to the mechanisms to avoid duplicative or conflicting rules.


3. When the two counterparties are established in third countries, EMIR would only apply under certain conditions developed under the regulatory technical standard (RTS). The mechanisms to avoid duplicative or conflicting rules would also apply in such case.


4. All transactions concluded between EU branches of non-equivalent third country entities are proposed to be captured by EMIR.

Operations involving indirectly third-country firms tentatively considered to have a direct, substantial and foreseeable effect within the Union and consequently subjected to EMIR:


1) OTC derivative contracts between EU branches of non-equivalent third countries,


2) guarantees provided by EU financial counterparties (determined by specific quantitative threshold - at least 8 billion euro equivalent for an aggregated notional amount and 5 percent of the sum of the current exposures (as defined in Regulation No 575/2013)) to cover OTC derivative contracts concluded by counterparties established in third countries.


The entities subject to the above rules would, however, be able to disapply the provisions of EMIR and apply the equivalent provisions in a third country, if at least one of the two counterparty is established in a jurisdiction for which the Commission adopted an implementing act on equivalence. 



5. Differently, ESMA believes that OTC derivative contracts between the EU branch of a non-EU entity and another non-EU entity, should be left to the regimes of the third countries involved, as that transaction would be a cross-border transaction between two non-EU entities, whereas in the previous case the transaction would be solely executed within the Union by two non-EU entities. For this purpose, ESMA believes that in this scenario the transaction is not subject to EMIR. 


The conditions under which the clearing obligation or the risk mitigation techniques should apply to a contract entered into by two third country counterparties relate to the direct, substantial and foreseeable effects of the contract within the Union or to the necessity or appropriateness to prevent the evasion of provisions of EMIR.


These conditions will be specified by the European financial regulator (ESMA) via regulatory technical standard (draft Commission Delegated Regulation supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on direct, substantial and foreseeable effect of contracts within the Union and prevention of evasion).


ESMA explained the above propositions that branches of third country entities established within the Union may be significant players in the European market and participate in the provision of liquidity on this market, thus the transactions of such EU branches would have a direct effect on the European markets if they are concluded with an EU counterparty or with the EU branch of a non-EU entity.


The transaction involving two non-EU entities operating through EU branches reasonably has been identified by ESMA as covered by EMIR.


Providing financial support in the form of a guarantee by the EU financial counterparty also appears a clear-cut instance of a transaction which might cause disruptions in the European market and consequently be positively targeted by EMIR provisions.

However, the exclusion of non-financial counterparties from this norm is insufficiently justified.


In turn, contracts entered into by subsidiaries established in third countries of EU parent are not considered by ESMA to have a direct, substantial and foreseeable effect within the Union and, consequently, subjected to EMIR.

ESMA stressed the fact subsidiaries are different legal entities and, unless explicitly guaranteed, the parent generally is  not  legally responsible for its subsidiaries.


Interestingly, ESMA also considered for EMIR cross-border purposes the events like the acceleration of the obligation between Specified Entities under ISDA Master Agreement as a consequence of default on the part of only one Specified Entity.

In spite of the fact that in the situation when counterparties established in a third country have listed for the purpose of acceleration or cross default in their master agreement a financial counterparty or a non-financial counterparty established in the Union, their derivative contracts may have an effect within the Union, the European financial regulator considers that it would be disproportionate to include such transactions in the scope of EMIR.

It was argued that the effect of the acceleration did not impact the parties to the obligation or the obligation itself but only the timing of the obligation and the transaction and resulting liabilities remained between the counterparties. The only change relate to the moment when the obligations become due. Nevertheless, the above arguments remain questionable.


Concise diagram illustrating the proposed scope of application of EMIR to third country entities pursuant to the draft RTS is attached below (the source: ESMA/2013/892).




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