Small Financial Counterparty (SFC or FC-)

Small Financial Counterparty (SFC or FC-) is:

   Financial counterparty as defined in Category 3 of the existing Commission Delegated Regulations on the clearing obligation:

- Commission Delegated Regulation (EU) 2015/2205 of 6 August 2015 supplementing Regulation (EU) No 648/2012, OJ L 314, 1.12.2015, p. 13;

- Commission Delegated Regulation (EU) 2016/592 of 1 March 2016 supplementing Regulation (EU) No 648/2012, OJ L 103, 19.4.2016, p. 5, and

- Commission Delegated Regulation (EU) 2016/1178 supplementing Regulation (EU) No. 648/2012, OJ L 195, 20.7.2016, p. 3;

   These are financial counterparties (and certain funds which are classified as non-financial counterparties) belonging to a group whose aggregate positions in OTC derivatives are EUR 8bn or below.

Under the new ‘small financials’ (or ‘FC-’) regime (as proposed by the European Commission in May 2017) financial counterparties whose derivatives activity falls below the EMIR Article 10 thresholds would not be required to clear.

Moreover:

- if a financial counterparty crosses any one of the asset class thresholds, it would be required to clear all contracts subject to the clearing obligation in other asset classes,

- financial counterparties below the thresholds (FC-) would still be subject to other EMIR requirements including margining requirements,

- all transactions are included in the calculation (unlike for the NFCs threshold, where hedging transactions do not count towards the threshold).

Proposal for a Regulation of the European Parliament and of the Council amending Regulation (EU) No 648/2012 as regards the clearing obligation, the suspension of the clearing obligation, the reporting requirements, the risk-mitigation techniques for OTC derivatives contracts not cleared by a central counterparty, the registration and supervision of trade repositories and the requirements for trade repositories (COM(2017)208) of May 2017 explains the reasons for introducing this new category of financial market counterparties as follows:

"The category of small financial counterparties (SFCs) should be defined in such a way that very small financial counterparties for which central clearing is not economically feasible because of their small volume of activity are not subject to the clearing obligation. This will lighten the burden on those SFCs that deal with a small volume of derivatives, while keeping the rest of the small financial counterparties (those belonging to the 'Category 3' defined in the relevant regulatory technical standards) obliged to clear once the phase-in period set in the regulatory technical standards ends, thus maintaining incentives for CCPs, clearing members and their clients to develop solutions to on-board this type of small financial counterparties."

Recital 6 of the said Proposal of May 2017 reads:

"Financial counterparties with a volume of activity in OTC derivatives markets that is too low to present an important systemic risk for the financial system and is too low for central clearing to be economically viable should be exempted from the clearing obligation while remaining subject to the requirement to exchange collateral to mitigate any systemic risk. The excess of the clearing threshold for at least one class of OTC derivative by a financial counterparty should however trigger the clearing obligation for all classes of OTC derivatives given the interconnectedness of financial counterparties and the possible systemic risk to the financial system that may arise if those derivative contracts are not centrally cleared."

International Swaps and Derivatives Association (ISDA) comments of 18 July 2017 on the ‘EMIR Refit’ proposal suggested some improvements of the above legislative project (p. 17).

According to ISDA the calculation required (in order for financial counterparties to be able to avoid having to clear) should be an optional calculation. ISDA argues that:

- only firms who want to avail themselves of the ‘FC-’ regime would have to undertake the calculation (in order to check that they can obtain this classification);

- some financial counterparties may want to clear their contracts anyway, or may believe that their derivatives activity is far in excess of the thresholds, and therefore may not want to have to undertake the calculation.

ISDA would also welcome further clarity in the Level 1 text to the effect that contracts entered into prior to the clearing obligation taking effect for financial counterparties that have exceeded the relevant thresholds in the annual test (for the first time) would not have to be ‘frontloaded’ (retroactively cleared) as of effective date.

Moreover, ISDA caveats some practical difficulties associated with introduction of such a de minimis threshold for financial counterparties - unless managed carefully.

In particular, trades with an entity that is a financial counterparty today that becomes a financial counterparty below a de minimis threshold at a future date would possibly have to be re-priced (when trade life cycle events are triggered), a process which would be resource-intensive.

Small financials' status under some other G20 jurisdictions

According to the aforementioned ISDA comments of 18 July 2017 on the ‘EMIR Refit’ proposal (p. 16) there is a complete exemption from Dodd Frank for small financial counterparties that are credit institutions in the US (commercial and savings banks and credit unions and farm credit institutions with less than $10 billion in assets).

Even financials that are not covered by the exemption may not have to post margin if they do not have material swaps exposure.

There is also some form of de minimis exemption for financial counterparties in several other G20 jurisdictions - see table below.

De minimis exemption for financial counterparties in several G20 jurisdictions

according to International Swaps and Derivatives Association (ISDA)

comments on the ‘EMIR Refit’ proposal, 18 July 2017 (p. 16, 17) and Chatham Financial

Proposal for a Regulation of the European Parliament and of the Council amending Regulation (EU) No 648/2012 as regards the clearing obligation, the suspension of the clearing obligation, the reporting requirements, the risk-mitigation techniques for OTC derivatives contracts not cleared by a central counterparty, the registration and supervision of trade repositories and the requirements for trade repositories, COM(2017)208, May 2017, Article 4a(1), Recital 6

Commission Staff Working Document Impact Assessment, Accompanying the document Proposal for a Regulation of the European Parliament and of the Council amending Regulation (EU) No 648/2012 as regards the clearing obligation, the suspension of the clearing obligation, the reporting requirements, the risk-mitigation techniques for OTC derivatives contracts not cleared by a central counterparty, the registration and supervision of trade repositories and the requirements for trade repositories {COM(2017) 208 final} {SWD(2017) 149 final}, 4.5.2017 SWD(2017) 148 final, p. 5

International Swaps and Derivatives Association (ISDA) comments on the ‘EMIR Refit’ proposal, 18 July 2017, p. 16 - 18

EMIR Regulation