EMIR legislative developments with respect to risk mitigation techniques reflect broader global tendencies (see for example IOSCO Risk Mitigation Standards for Non-centrally Cleared OTC Derivatives FR01/2015 of 28 January 2015. Under EMIR rules standardized derivative contracts should be cleared through central counterparties while contracts not cleared by a CCP require exchange of collateral and counterparties must hold adequate capital and have mitigation techniques in place. An important observation has been made (Basel Committee on Banking Supervision, Board of the International Organization of Securities Commissions, Margin requirements for non-centrally cleared derivatives, March 2015, p. 7), only standardised derivatives are suitable for central clearing. However, a substantial fraction of derivatives is not standardised and cannot be centrally cleared.

 

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Risk-mitigation techniques for OTC derivative contracts not cleared by a CCP
(Article 11(1) - (12) of EMIR (
Regulation (EU) No 648/2012))

 

Article 11

Risk-mitigation techniques for OTC derivative contracts not cleared by a CCP

1. Financial counterparties and non-financial counterparties that enter into an OTC derivative contract not cleared by a CCP, shall ensure, exercising due diligence, that appropriate procedures and arrangements are in place to measure, monitor and mitigate operational risk and counterparty credit risk, including at least:
(a) the timely confirmation, where available, by electronic means, of the terms of the relevant OTC derivative contract;
(b) formalised processes which are robust, resilient and auditable in order to reconcile portfolios, to manage the associated risk and to identify disputes between parties early and resolve them, and to monitor the value of outstanding contracts.
2. Financial counterparties and non-financial counterparties referred to in Article 10 shall mark-to-market on a daily basis the value of outstanding contracts. Where market conditions prevent marking-to-market, reliable and prudent marking-to-model shall be used.
3. Financial counterparties shall have risk-management procedures that require the timely, accurate and appropriately segregated exchange of collateral with respect to OTC derivative contracts that are entered into on or after 16 August 2012. Non-financial counterparties referred to in Article 10 shall have risk-management procedures that require the timely, accurate and appropriately segregated exchange of collateral with respect to OTC derivative contracts that are entered into on or after the clearing threshold is exceeded.
4. Financial counterparties shall hold an appropriate and proportionate amount of capital to manage the risk not covered by appropriate exchange of collateral.
5. The requirement laid down in paragraph 3 of this Article shall not apply to an intragroup transaction referred to in Article 3 that is entered into by counterparties which are established in the same Member State provided that there is no current or foreseen practical or legal impediment to the prompt transfer of own funds or repayment of liabilities between counterparties.
6. An intragroup transaction referred to in Article 3(2)(a), (b) or (c) that is entered into by counterparties which are established in different Member States shall be exempt totally or partially from the requirement laid down in paragraph 3 of this Article, on the basis of a positive decision of both the relevant competent authorities, provided that the following conditions are fulfilled:
(a) the risk-management procedures of the counterparties are adequately sound, robust and consistent with the level of complexity of the derivative transaction;
(b) there is no current or foreseen practical or legal impediment to the prompt transfer of own funds or repayment of liabilities between the counterparties.

If the competent authorities fail to reach a positive decision within 30 calendar days of receipt of the application for exemption, ESMA may assist those authorities in reaching agreement in accordance with its powers under Article 19 of Regulation (EU) No 1095/2010.

7. An intragroup transaction referred to in Article 3(1) that is entered into by non-financial counterparties which are established in different Member States shall be exempt from the requirement laid down in paragraph 3 of this Article, provided that the following conditions are fulfilled:
(a) the risk-management procedures of the counterparties are adequately sound, robust and consistent with the level of complexity of the derivative transaction;
(b) there is no current or foreseen practical or legal impediment to the prompt transfer of own funds or repayment of liabilities between the counterparties.

The non-financial counterparties shall notify their intention to apply the exemption to the competent authorities referred to in Article 10(5). The exemption shall be valid unless either of the notified competent authorities does not agree upon fulfilment of the conditions referred to in point (a) or (b) of the first subparagraph within three months of the date of the notification.

8. An intragroup transaction referred to in Article 3(2)(a) to (d) that is entered into by a counterparty which is established in the Union and a counterparty which is established in a third-country jurisdiction shall be exempt totally or partially from the requirement laid down in paragraph 3 of this Article, on the basis of a positive decision of the relevant competent authority responsible for supervision of the counterparty which is established in the Union, provided that the following conditions are fulfilled:
(a) the risk-management procedures of the counterparties are adequately sound, robust and consistent with the level of complexity of the derivative transaction;
(b) there is no current or foreseen practical or legal impediment to the prompt transfer of own funds or repayment of liabilities between the counterparties.
9. An intragroup transaction referred to in Article 3(1) that is entered into by a non-financial counterparty which is established in the Union and a counterparty which is established in a third-country jurisdiction shall be exempt from the requirement laid down in paragraph 3 of this Article, provided that the following conditions are fulfilled:
(a) the risk-management procedures of the counterparties are adequately sound, robust and consistent with the level of complexity of the derivative transaction;
(b) there is no current or foreseen practical or legal impediment to the prompt transfer of own funds or repayment of liabilities between the counterparties.

The non-financial counterparty shall notify its intention to apply the exemption to the competent authority referred to in Article 10(5). The exemption shall be valid unless the notified competent authority does not agree upon fulfilment of the conditions referred to in point (a) or (b) of the first subparagraph within three months of the date of notification.

10. An intragroup transaction referred to in Article 3(1) that is entered into by a non-financial counterparty and a financial counterparty which are established in different Member States shall be exempt totally or partially from the requirement laid down in paragraph 3 of this Article, on the basis of a positive decision of the relevant competent authority responsible for supervision of the financial counterparty, provided that the following conditions are fulfilled:
(a) the risk-management procedures of the counterparties are adequately sound, robust and consistent with the level of complexity of the derivative transaction;
(b) there is no current or foreseen practical or legal impediment to the prompt transfer of own funds or repayment of liabilities between the counterparties.

The relevant competent authority responsible for supervision of the financial counterparty shall notify any such decision to the competent authority referred to in Article 10(5). The exemption is valid unless the notified competent authority does not agree upon fulfilment of the conditions referred to in point (a) or (b) of the first subparagraph. If there is disagreement between the competent authorities, ESMA may assist those authorities in reaching an agreement in accordance with its powers under Article 19 of Regulation (EU) No 1095/2010.

11. The counterparty of an intragroup transaction which has been exempted from the requirement laid down in paragraph 3 shall publicly disclose information on the exemption.

A competent authority shall notify ESMA of any decision adopted pursuant to paragraph 6, 8 or 10, or any notification received pursuant to paragraph 7, 9 or 10, and shall provide ESMA with the details of the intragroup transaction concerned.

12. The obligations set out in paragraphs 1 to 11 shall apply to OTC derivative contracts entered into between third country entities that would be subject to those obligations if they were established in the Union, provided that those contracts have a direct, substantial and foreseeable effect within the Union or where such obligation is necessary or appropriate to prevent the evasion of any provision of this Regulation.
[...]

 

The aforementioned document refers to the Global Financial Stability Report, April 2010, Chapter 3, which assumes that one quarter of interest rate swaps, one third of credit default swaps, and two thirds of other OTC derivatives will not be sufficiently standardised and liquid to be centrally cleared. Consequently, the preliminary EMIR exercise for firms is to differentiate between derivative contracts subject to clearing and those to which risk mitigation techniques apply and, moreover, precisely identify derivatives subject to each of the above relevant requirements.

 

EMIR's catalogue of risk mitigation techniques

 

Risk mitigation techniques under EMIR include:

 

Dates of application

 

The dates on which the relevant requirements for OTC derivatives not cleared by a CCP apply are:

- for portfolio reconciliation, portfolio compression and dispute resolution - 15 September 2013;

- for timely confirmations and daily valuations - 15 March 2013.

 

Coverage 

 

In ESMA's Q&As the following point has been raised:

"Do the procedures prescribed in Article 11 of EMIR have to be implemented between a financial or non-financial counterparty subject to EMIR, and a counterparty that is exempted as defined in Article 1 of EMIR?"

The ESMA's position in that regard is:

"No. However, both the exempted and the non-exempted counterparties may on a voluntary basis choose to establish any contractual arrangements with the objective of replicating the obligations of Article 11 of EMIR."

Similarly, the EU-based counterparty is not required to apply risk mitigation techniques under Art. 11 EMIR when it executes OTC-derivative contracts cleared by a third-country CCP not recognized under Art. 25 EMIR. ESMA's reasoning in that regard was that Article 11 of EMIR only applies to OTC derivative contracts not cleared by a CCP, irrespective of its status under EMIR. The conditions under which financial and non-financial counterparties can be serviced by third-country CCPs are generally addressed in Articles 25 and 89 of EMIR. This covers the transitional period during which financial and non-financial counterparties can be serviced by third-country CCPs that have applied for recognition before 15 September 2013, as well as after the transitional period when financial and non-financial counterparties can still access non recognised third-country CCPs as clients (via a third-country clearing member only) if they wish to clear products other than derivatives subject to a clearing obligation under EMIR.

With regards to the clearing obligation, Article 4(3) clarifies that clearing with a third country CCP is only allowed when that CCP is recognised under Article 25, irrespective of the capacity in which EU-based counterparties access the CCP (as clearing members, clients or through indirect clearing arrangements).

 

Delegation issue

 

The practical ambiguity arose whether entities subjected to EMIR are allowed to delegate the risk-management procedures and arrangements to an asset manager, who is providing portfolio management service to the counterparty on an agency basis. Such delegation is in principle possible to the extent it is permitted under the relevant applicable national or EU legislation regulating the activities of asset managers or of investment funds.

 

Special treatment for C6 energy derivatives contracts

 

Pursuant to MiFID II Directive EMIR risk mitigation techniques will not apply during the 42-month transitional  period (counted from the entry into application of the said Directive) to C6 energy derivatives (i.e. physically settled coal and oil traded on an OTF) entered into: 

- by non-financial counterparties below EMIR clearing threshold, or

- by non-financial counterparties that will be authorised for the first time as investment firms as from the date of entry into application of the MiFID II.

 

Other impacts of C6 energy derivatives' regulation on EMIR arrangements.

 

IMG 0744   Documentation

 

Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories 


Commission Delegated Regulation (EU) No 149/2013 of 19 December 2012 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on indirect clearing arrangements, the clearing obligation, the public register, access to a trading venue, non-financial counterparties, and risk mitigation techniques for OTC derivatives contracts not cleared by a CCP, Chapter VIII

  

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