Dispute resolution procedure requirement under EMIR
- Category: EMIR
EMIR requirements with respect to dispute resolution are stipulated in Article 15 of the regulatory technical standards (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 - ‘Commission Delegated Regulation on Clearing Thresholds’ or ‘RTS’)) - see box.
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6 July 2021
In the EU Official Journal were published:
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EMIR Regulation in Article 11(1) requires that counterparties that enter into an OTC derivative contract not cleared by a CCP, must have, exercising due diligence, appropriate procedures and arrangements in place to measure, monitor and mitigate operational risk and counterparty credit risk, including at least formalised processes which are robust, resilient and auditable in order to identify disputes between parties early and resolve them.
The said requirement applies equally to:
- financial counterparties, and
- non-financial counterparties.
The process for setting regulatory requirements for dispute resolution has a broader reach and legislative developments in that regard are not EU-specific (the example: IOSCO Risk Mitigation Standards for Non-centrally Cleared OTC Derivatives FR01/2015 of 28 January 2015 p. 14 - 15).
Both instruments follow broadly the same line, the latter being of a more general nature.
Article 15 of the Commission Delegated Regulation on Clearing Thresholds
Dispute resolution
1. When concluding OTC derivative contracts with each other, financial counterparties and non-financial counterparties shall have agreed detailed procedures and processes in relation to:
(a) the identification, recording, and monitoring of disputes relating to the recognition or valuation of the contract and to the exchange of collateral between counterparties. Those procedures shall at least record the length of time for which the dispute remains outstanding, the counterparty and the amount which is disputed;
(b) the resolution of disputes in a timely manner with a specific process for those disputes that are not resolved within five business days.
2. Financial counterparties shall report to the competent authority designated in accordance with Article 48 of Directive 2004/39/EC any disputes between counterparties relating to an OTC derivative contract, its valuation or the exchange of collateral for an amount or a value higher than EUR 15 million and outstanding for at least 15 business days.
Required frequency of the disputes' reporting
The frequency of the relevant reporting to a competent authority on disputes was doubtful on the ground of the RTS. Due to the absence of explicit legislative language different timelines were proposed (e.g. monthly, quarterly etc.).
The regulatory stance in that regard is, as a minimum, financial counterparties are expected to make a monthly notification of any disputes outstanding in the preceding month, however, national competent authorities may require more frequent reporting of outstanding disputes.
Valuation
The another potential problem is whether detailed policies and procedures mentioned in Article 15 of the RTS refer to valuation differences at the trade (or contract) level or margin disputes which occur at the portfolio level.
The were presented views that since the portfolio reconciliation requirement included both collateralised and non-collateralised trades the word 'dispute' here referred to valuation differences observed in the reconciliation process.
However, as ESMA clarified, the valuation is the one attributed to each contract in accordance with Article 11(2) of EMIR (the question was: "What is the 'valuation' referred to in Article 15 of the RTS on OTC derivatives?").
The amount or value of outstanding disputes should be calculated and reported on a trade by trade basis whenever possible. However, a portfolio basis may be used if the disputed valuation or collateral, for example initial margin, is calculated at the portfolio level.
Minor discrepancies
There may be also the ambiguity at which point in time the issue of a "dispute" arises and what are the representative characteristics which differentiate a "dispute" from a discrepancy that party expect can be easily resolved at an operational level. It seems that a seriousness of the issue should be taken into account when determining on this question in the EMIR regulatory sense.
Referring to this issue ESMA in its Questions and Answers on EMIR stated that "Counterparties may agree upfront that discrepancies that amount to a value below a pre-defined threshold do not count as disputes. If that is the case, these minor discrepancies would not count as disputes. All the other discrepancies would give rise to disputes and be treated according to Article 15 of the RTS on OTC derivatives."
ESMA has also explained that a dispute in the sense of the provision at issue may be also caused by cashflows settlement breaks.
Industry standards
Parties wishing to implement EMIR dispute resolution requirements into their contractual documentation have at their disposal at least two master agreements:
- the ISDA 2013 Portfolio Reconciliation, Dispute Resolution and Disclosure Protocol published by the International Swaps and Derivatives Association, Inc. (the "ISDA Protocol"), and
- EFET's form of EMIR Risk Mitigation Techniques Agreement (the ERMTA).
As EFET underlines in its Guidance Notes, it is intended that the core obligations under both the ISDA Protocol and the ERMTA are to apply to transactions that are subject to the applicable EMIR obligations, including where those transactions are not documented under an ISDA Master Agreement (in the case of the ISDA Protocol) or an EFET General Agreement (in the case of the ERMTA).
The possibility to include the above standards into other than ISDA and EFET legal documentation may seem a convenient and swift way to cope with EMIR dispute resolution burdens (as well as other EMIR risk mitigation techniques). However, as is also reserved in the EFET's and ISDA's responsibility clauses, market participant is solely responsible for EMIR compliance as well as for safeguarding its own interests.
Besides, the ERMTA text provides an additional argument that the term "dispute" is understood in the EMIR nomenclature in the very specific sense.
Also remedies for breach of the ERMTA when it comes to EMIR requirements have been arranged in the specific manner, namely a failure by a party to comply with the obligations set forth in the ERMTA does not amount to a circumstance that permits termination of the EMIR relevant transaction; and neither will such a failure amount to an event of default, termination event, material reason, or any similar such term, which may permit the termination of the EMIR relevant transaction or any other transactions.
Generally, describing responsibility at issue it is useful to mention that under both the ERMTA as well as ISDA Protocol, failure to comply with contractual EMIR risk mitigation techniques requirements, dispute resolution including, does not represent an event of default, termination event or material reason (without prejudice to rights and remedies provided by law).
The effect is, that under the above master agreements we have a bizarre, to some extent, situation of two distinct dispute resolution procedures designed for different purposes, with separate remedies and responsibility for non-compliance. The inter-dependencies of these procedures require more in-depth analysis.
Interesting and useful feature of ERMTA is that parties may choose to apply its terms to transactions that are not EMIR-relevant transactions and to transactions, in respect of which there is some doubt as to whether or not they are embraced by EMIR risk mitigation requirements.
The above-mentioned IOSCO risk mitigation standards contain an express remark (p. 15) that an agreement on a dispute resolution mechanism or process "would not prevent covered entities from pursuing other options for recourse (e.g. arbitration or legal proceedings)".
Starting date for EMIR dispute resolution requirements
ESMA in its Questions and Answers on EMIR clarified dispute resolution requirements apply to the portfolio of outstanding OTC derivative contracts. Therefore as the relevant technical standards entered into force on 15 September 2013, the requirements apply to the portfolio of outstanding contracts as of such date.
Third-country application and equivalence
ESMA in its Questions and Answers on EMIR also observed that Article 11 of EMIR, which provides the basis for these requirements, applies wherever at least one counterparty is established within the EU.
Therefore, where an EU counterparty is transacting with a third country entity, the EU counterparty would be required to ensure that the requirements for dispute resolution are met for the relevant portfolio and/or transactions even though the third country entity would not itself be subject to EMIR.
However, if the third country entity is established in a jurisdiction for which the Commission has adopted an implementing act (under Article 13 of EMIR), the counterparties could comply with equivalent rules in the third country.
US
The equivalence status to the US dispute resolution legal framework has been granted by the Commission Implementing Decision (EU) 2017/1857 of 13 October 2017 on the recognition of the legal, supervisory and enforcement arrangements of the United States of America for derivatives transactions supervised by the Commodity Futures Trading Commission as equivalent to certain requirements of Article 11 of Regulation (EU) No 648/2012 of the European Parliament and Council on OTC derivatives, central counterparties and trade repositories.
The US counterpart CFTC issued the parallel media report: CFTC Comparability Determination on EU Margin Requirements and a Common Approach on Trading Venues, Release: pr7629-17, October 13, 2017).
Article 1 of the Commission Implementing Decision (EU) 2017/1857 of 13 October 2017 on the recognition of the legal, supervisory and enforcement arrangements of the United States of America for derivatives transactions supervised by the Commodity Futures Trading Commission as equivalent to certain requirements of Article 11 of Regulation (EU) No 648/2012 of the European Parliament and Council on OTC derivatives, central counterparties and trade repositories
For the purposes of Article 13(3) of Regulation (EU) No 648/2012, the legal, supervisory and enforcement arrangements of the United States of America (USA) for operational risk-mitigation techniques that are applied to transactions regulated as ‘swaps’ by the Commodity Futures Trading Commission (CFTC) in accordance with section 721(a)(21) of the Dodd-Frank Act and that are not cleared by a CCP shall be considered as equivalent to the requirements set out in paragraphs 1 and 2 of Article 11 of Regulation (EU) No 648/2012, where at least one of the counterparties to those transactions is established in the USA and registered with the CFTC as a swap dealer or major swap participant.
The disputes resolution requirements as a operational risk mitigation technique for OTC derivative contracts not cleared by a CCP are added in a section 4s(i) to the Commodity Exchange Act (CEA) by section 731 of the Dodd-Frank Act and apply to swap dealers and major swap participants, as defined in the CEA.
Consequently, it should be noted that the said Commission Implementing Decision (EU) 2017/1857 of 13 October 2017:
- covers the legal, supervisory and enforcement arrangements regarding disputes resolution applicable to swap dealers and major swap participants established in the USA that are authorised and supervised in accordance with the CFTC Regulations;
- does not encompass USA legal, supervisory and enforcement arrangements applicable to persons that are registered with the Securities and Exchange Commission as a security-based swap dealer or a major security-based swap participant pursuant to the Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.).
CFTC Regulations on operational risk mitigation techniques for OTC derivative contracts not cleared by a CCP contain similar obligations to those provided for in Article 11(1) EMIR.
In particular, Subpart I of Part 23 of the CFTC Regulations contains specific detailed requirements regarding, among others, disputes resolution applicable to OTC derivative contracts not cleared by a CCP.
Taking into account the limited impact due to the difference in scope of the requirements for agreements on how disputes are resolved, the requirements set out in the CFTC Regulation are considered equivalent to the requirements of the EMIR Regulation on dispute resolution.
The said Commission Decision (EU) 2017/1857 concludes in Recital 9 that in relation to swaps that are under the jurisdiction of the CFTC, as defined in section 1a(47) of the CEA, the CFTC's legal, supervisory and enforcement arrangements applicable to swap dealers and major swap participants are equivalent to the disputes resolution requirements set out in the EMIR applicable to OTC derivative contracts not cleared by a CCP, as laid down in Article 11(1) EMIR.
The effect of the above statement is that market participants are allowed to comply with only one set of rules and to avoid duplicative or conflicting rules, i.e. where at least one of the counterparties is established in the US, it is deemed to have fulfilled EMIR disputes resolution requirements by complying with the requirements set out in the US legal regime.
However, it is noteworthy, the CFTC’s equivalence determination applies only where both the entity and the transaction are otherwise subject to both the CFTC and EU dispute resolutions regulations, and not when a swap dealer voluntarily complies with the respective regime.
Japan
On 25 April 2019 the European Commission adopted Commission Implementing Decision (EU) 2019/684 of 25 April 2019 on the recognition of the legal, supervisory and enforcement arrangements of Japan for derivatives transactions supervised by the Japan Financial Services Agency as equivalent to the dispute resolution requirements of Article 11 of Regulation (EU) No 648/2012 of the European Parliament and Council on OTC derivatives, central counterparties and trade repositories.
Australia
On 6 July 2021 in the EU Official Journal was published Commission Implementing Decision (EU) 2021/1106 of 5 July 2021 on the recognition of the legal, supervisory and enforcement arrangements of Australia for derivatives transactions supervised by the Australian Prudential Regulation Authority as equivalent to certain requirements of Article 11 of Regulation (EU) No 648/2012 of the European Parliament and of the Council on OTC derivatives, central counterparties and trade repositories, which states that, with regard to dispute resolution, the requirements set out in Prudential Standard CPS 226 cannot be considered equivalent as, contrary to Delegated Regulation (EU) No 149/2013, that Prudential Standard does not provide for a specific process for disputes that are not resolved within five working days.
Canada
On 6 July 2021 in the EU Official Journal was published Commission Implementing Decision (EU) 2021/1104 of 5 July 2021 on the recognition of the legal, supervisory and enforcement arrangements of Canada for derivatives transactions supervised by the Office of the Superintendent of Financial Institutions as equivalent to certain requirements of Article 11 of Regulation (EU) No 648/2012 of the European Parliament and of the Council on OTC derivatives, central counterparties and trade repositories - for the purposes of Article 13(3) of Regulation (EU) No 648/2012, the legal, supervisory and enforcement arrangements of Canada for dispute resolution obligations set out in Guideline B-7 that are applied to non-centrally cleared derivative transactions regulated by the Office of the Superintendent of Financial Institutions (‘OSFI’) shall be considered as equivalent to the requirements set out in Article 11(1) of Regulation (EU) No 648/2012, where at least one of the counterparties to those transactions is established in Canada and is a Covered Federally Regulated Financial Institution (‘Covered FRFIs’) as defined under Guideline E-22.
Singapore
On 6 July 2021 in the EU Official Journal was published Commission Implementing Decision (EU) 2021/1105 of 5 July 2021 on the recognition of the legal, supervisory and enforcement arrangements of Singapore for derivatives transactions supervised by the Monetary Authority of Singapore as equivalent to certain requirements of Article 11 of Regulation (EU) No 648/2012 of the European Parliament and Council on OTC derivatives, central counterparties and trade repositories, which states that for the purposes of Article 13(3) of Regulation (EU) No 648/2012, the legal, supervisory and enforcement arrangements of Singapore for dispute resolution that are applied to transactions regulated as OTC derivatives by the Monetary Authority of Singapore (‘MAS’) and that are not cleared by a CCP shall be considered as equivalent to the corresponding requirements set out in paragraphs 1 and 2 of Article 11 of Regulation (EU) No 648/2012, where at least one of the counterparties to those transactions is established in Singapore and is a ‘MAS Covered Entity’ as defined under the Guidelines on margin requirements for non-centrally cleared OTC derivative contracts.
Hong Kong
On 6 July 2021 in the EU Official Journal was published Commission Implementing Decision (EU) 2021/1107 of 5 July 2021 on the recognition of the legal, supervisory and enforcement arrangements of Hong Kong for derivatives transactions supervised by the Hong Kong Monetary Authority as equivalent to certain requirements of Article 11 of Regulation (EU) No 648/2012 of the European Parliament and of the Council on OTC derivatives, central counterparties and trade repositories - for the purposes of Article 13(3) of Regulation (EU) No 648/2012, the legal, supervisory and enforcement arrangements of Hong Kong for dispute resolution, that are applicable to non-centrally cleared derivative transactions regulated by the Hong Kong Monetary Authority (‘HKMA’) shall be considered equivalent to the requirements set out in paragraphs 1 and 2 of Article 11 of that Regulation where at least one of the counterparties to such a transaction is an authorised institution as defined in section 2(1) of the Banking Ordinance and subject to the risk mitigation requirements set out in the HKMA’s Supervisory Policy Manual module CR-G-14 entitled ‘Non-centrally Cleared OTC Derivatives Transactions – Margin and Other Risk Mitigation Standards’.
Article 13 EMIR
Mechanism to avoid duplicative or conflicting rules
1. The Commission shall be assisted by ESMA in monitoring and preparing reports to the European Parliament and to the Council on the international application of principles laid down in Articles 4, 9, 10 and 11, in particular with regard to potential duplicative or conflicting requirements on market participants, and recommend possible action.
2. The Commission may adopt implementing acts declaring that the legal, supervisory and enforcement arrangements of a third country:
(a) are equivalent to the requirements laid down in this Regulation under Articles 4, 9, 10 and 11;
(b) ensure protection of professional secrecy that is equivalent to that set out in this Regulation; and
(c) are being effectively applied and enforced in an equitable and non-distortive manner so as to ensure effective supervision and enforcement in that third country.
Those implementing acts shall be adopted in accordance with the examination procedure referred to in Article 86(2).
3. An implementing act on equivalence as referred to in paragraph 2 shall imply that counterparties entering into a transaction subject to this Regulation shall be deemed to have fulfilled the obligations contained in Articles 4, 9, 10 and 11 where at least one of the counterparties is established in that third country.
4. The Commission shall, in cooperation with ESMA, monitor the effective implementation by third countries, for which an implementing act on equivalence has been adopted, of the requirements equivalent to those laid down in Articles 4, 9, 10 and 11 and regularly report, at least on an annual basis, to the European Parliament and the Council. Where the report reveals an insufficient or inconsistent application of the equivalent requirements by third country authorities, the Commission shall, within 30 calendar days of the presentation of the report, withdraw the recognition as equivalent of the third country legal framework in question. Where an implementing act on equivalence is withdrawn, counterparties shall automatically be subject again to all requirements laid down in this Regulation.
Special treatment for C6 energy derivatives contracts
Pursuant to MiFID II Directive EMIR timely confirmation requirements 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.
Implementation issues
It is noteworthy that the particular term appears in the language of Article 15 of RTS namely five business days as a deadline above which the process should be "specific". This is a new issue to include in the drafting for the contracts.
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