On 7 December 2022, the Commission put forward a proposal[1] to amend the European Market Infrastructure Regulation[2] (EMIR) with the aim of encouraging clearing of derivative transactions by simplifying clearing procedures and increasing the resilience and efficiency of Central Clearing Counterparties (CCPs) in the EU.
This re-vamp of EMIR, dubbed EMIR 3.0, has been the subject of much debate by various industry bodies, whose reactions to the proposed changes have varied from the wary to the outright alarmed. EMIR has been the subject of many changes throughout the years, notably through the enactment of the EMIR Refit Regulation[3] in 2019 and other changes which have, to varying degrees, impacted the obligations of derivative market participants, including through updating of reporting requirements and other piecemeal changes.
EMIR 3.0 can is arguably a culmination of an ongoing process of re-examining the regulation of the EU derivatives market. This process, motivated by a need to improve a regulatory regime which was felt to be too burdensome for smaller industry participants, was further spurred along by recent volatility in the energy derivatives markets. Exorbitant increases in gas and electricity prices, somewhat expected during a post-COVID boom in the demand for energy were aggravated by the outbreak of the Russo-Ukrainian War and the sudden reduction (and in same cased complete halting) of energy supplies from Russia. This sharp increase in energy prices resulted in turbulence in the commodity derivatives markets – energy companies were required to post increasing amounts of cash collateral to CCPs and faced difficulty in meeting CCP margin calls, straining liquidity in an already turbulent sector.
The emergency measures put in place to alleviate the pressures faced by the energy industry are slated to become a permanent of derivatives market regulations once the amendments put forward in the EMIR 3.0 Proposal[4] come into force.
1. Clearing obligation
Active accounts
Among the more far-reaching changes proposed by EMIR 3.0 is the introduction of a new Article 7a regarding active accounts. This new requirement provides that financial counterparties (FCs) and non-financial counterparties (NFCs) that are subject to the clearing obligation in terms of EMIR are required to clear at least a proportion of the following derivative contracts at accounts held with EU CCPs:
- interest rate derivatives denominated in euro and Polish zloty;
- Credit Default Swaps (CDS) denominated in euro; and
- Short-Term Interest Rate Derivatives (STIR) denominated in euro.
The actual proportion of these contracts which will need to be cleared through the active account and other issues such as reporting requirements of transactions cleared at such active accounts still need to be set out by means of ESMA regulatory technical standards.
The derivative contracts listed in the proposed Article 7a have been identified by ESMA as being of substantial systemic importance for EU financial stability. Therefore, by mandating that at least a proportion of these are cleared through an account held with an EU CCP, the argument put forward in EMIR 3.0 is that this reduces third-country risk exposure.
In the run-up to EMIR 3.0, the issue as to whether the EU would grant UK CCPs permanent equivalence was the subject of much debate as unlike other equivalence decisions for other third countries, the one grated to UK CCPs was subject to a time limit expiring on 30 June 2025. It was clear from the outset that the UK CCP equivalence decision was a short-term measure to avoid market upheaval until such time as the Commission could put forward measures to reduce dependence on UK CCPs.[5]
The ‘active account’ requirement has been criticised as being an unfair attempt at pressuring EU derivative counterparties to cut ties with CCPs based in the UK. This proposal was not met positively by the market with industry groups claiming that these measures would make EU firms less competitive by hindering their ability to provide best execution for their clients and imposing additional costs.[6]
Clearing threshold
Under the current EMIR rules, the threshold to determine whether a derivative counterparty is subject to the clearing obligation is calculated by taking the aggregate month-end average OTC derivative position for the previous twelve months.
The Commission has proposed to amend the calculation methodology such that only derivative contracts that are not cleared at an EU CCP or a recognised third-country CCP should be included in this calculation. This proposal mitigates the imposition of the ‘active account’ clearing requirement because derivative transactions which are cleared by a third country CCP will be included in the scope of the clearing threshold calculations.
This amendment to the clearing threshold calculation methodology incentivizes clearing of derivative transaction. It also recognises that cleared transactions which are subject to margin requirements pose significantly less risk that OTC transactions, adopting a more proportionate approach to the clearing obligation.
2. Intragroup transactions
Among the proposals which were met with approval by industry groups are those relating to expanding exemptions for cross-border intragroup transactions. EMIR currently exempts intragroup transactions from the clearing obligation as well as margin requirements. However, the applicability of an intragroup exemption currently requires that if the intragroup counterparty to a derivative transaction is established in a third country, the Commission must have adopted an implementing act under Article 13(2) in respect of such a third country.[7] Implementing acts issued under Article 13(2) of EMIR are essentially equivalence decisions whereby the Commission declares that the legal, supervisory and enforcement arrangements of a third country meet the necessary requirements.
EMIR 3.0 is proposing to that the need for an equivalence decision is replaced by a list of jurisdictions for which an exemption cannot be granted. Article 13 therefore will be deleted and instead third countries which are considered to be high-risk jurisdictions for anti-money laundering and counter terrorist financing will be excluded from the intragroup exemption in terms of EMIR.[8]
However, while the intragroup exemption for clearing and margin requirements will be simplified and more accessible, the same cannot be said for the intragroup exemption from reporting obligations. Currently Article 9 provides that the reporting obligation does not apply to derivative contracts within the same group where at least one of the counterparties is a NFC (or would be qualified as a NFC if established in the EU) provided that:
- both counterparties are included in the same consolidation on a full basis;
- both counterparties are subject to appropriate centralised risk evaluation, measurement and control procedures; and
- the parent undertaking is not a financial counterparty.
This exemption shall be removed in order to improve visibility of such transactions.
3. Proposals in relation to NFCs
Clearing obligation for NFCs
In respect of non-financial counterparties, amendments to Article 10 of EMIR will require the European Securities and Markets Authority (ESMA) to review:
the hedging exemption criteria (i.e. the criteria for establishing which OTC derivative contracts are objectively measurable as reducing risks); and
whether the level of thresholds above which the non-financial entities become subject to the clearing obligation, as well as to consider whether the current asset classes of OTC derivatives (interest rate, foreign exchange, credit and equity derivatives) remain accurate.
Requirement for NFCs to post margin
It is proposed that Article 11 of EMIR be amended to grant NFCs that become subject to the obligation to exchange collateral for OTC derivative contracts not cleared by a CCP for the first time, a grace period of four months in which to negotiate and test the arrangements to exchange collateral.
4. Amendments to CCP requirements
Collateral requirements
The increased demand for collateral as a consequence of the regulatory requirements of EMIR has been a concern ever since it first came into force.[9] Due to the recent energy crisis, the European commodities derivatives market was put under immense pressure to meet margin calls imposed by CCPs.[10] As an emergency measure, the Commission amended the EMIR regulatory technical standards to raise the clearing threshold for OTC derivative commodity contracts and broadened the list of eligible assets for use as collateral.
The EMIR 3.0 Proposal includes a permanent amendment to Article 46 of EMIR to permit EU CCPs to allow bank guarantees and public guarantees to be considered eligible as highly liquid collateral, provided that they are unconditionally available upon request within the liquidation period and making sure a CCP takes them into account when calculating its overall exposure to the bank. In addition, Article 41 of EMIR is proposed to be amended to require CCPs to continuously revise the level of margin to reflect current market conditions and to take into account the effects of margin requirements on the liquidity position of their participants as well as the wider procyclical effects which such requirements may have on market liquidity.
CCP participation requirements
NFC wishing to become direct clearing members, rather than using a FC as a financial intermediary, to clear trade will be subject to additional margin and default funds requirements. In addition, amendments to Article 37 of EMIR will prevent NFCs from offering client clearing services and they will only be allowed to keep CCP accounts for assets and positions held for their own account. In this regard, it is proposed that ESMA will issue draft RTS on the elements to be considered when determining criteria for direct access to CCPs by NFCs.
Concluding remarks
The amendments set out in the EMIR 3.0 Proposal are intended to make the European clearing market more attractive to derivative counterparties by simplifying collateral requirements and clearing processes. The need for these measures has long been felt by market participants however came to the fore during the recent energy crisis.
Counterparties to derivative contracts which benefit from the intragroup exemption should also take note of the changes to this exemption set out in the EMIR 3.0 Proposal and NFCs should also be on the look-out for upcoming changes to the applicability of the clearing threshold obligation.
[1] This proposal is part of a wider legislative package to strengthen the Capital Markets Union. A full list of the proposed changes can be found here: https://finance.ec.europa.eu/publications/capital-markets-union-clearing-insolvency-and-listing-package_en.
[2] 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 (as amended).
[3] Regulation (EU) 2019/834 of the European Parliament and of the Council of 20 May 2019 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 derivative contracts not cleared by a central counterparty, the registration and supervision of trade repositories and the requirements for trade repositories.
[4] Proposal for a Regulation of the European Parliament and of the Council amendment Regulations (EU) No 648/2012, (EU No 575/2013 and (EU) 2017/1131 as regards measures to mitigate excessive exposures to third-country central counterparties and improve the efficiency of Union clearing markets COM(2022) 697 final.
[5] See: https://ec.europa.eu/commission/presscorner/detail/en/ip_22_665.
[6] ISDA, AIMA, EFAMA, FIA Statement on European Commission’s Proposed Amendments to EMIR, Press Release, 2 February 2023 available here: https://www.efama.org/newsroom/news/isda-aima-efama-fia-statement-european-commission-s-proposed-amendments-emir.
[7] ESMA, ‘Questions and Answers, Implementation of the Regulation (EU) No 648/2021 on OTC derivatives, central counterparties and trade repositories (EMIR)’ dated 20 May 2021, Question and Answer 6(b).
[8] The repeal of Article 13 is also relevant for the purposes of the Capital Requirements Regulation (CRR). Article 382(4) of the CRR currently cross-refers to the need of an equivalence decision under Article 13 of EMIR. In this regard, the proposed amendment adjusts the scope of the own funds requirement for credit valuation adjustment risk, clarifying which intragroup transactions can be excluded from that requirement.
[9] European Central Bank, ‘Collateral Eligibility and Availability’ July 2014, available here: https://www.ecb.europa.eu/pub/pdf/other/cea201407en.pdf
[10] Anna Shiryaevskaya, ‘Energy Trading Stressed by Margin Calls of $1.5 Trillion’ 6 September 2022, Bloomberg, available here: https://www.bloomberg.com/news/articles/2022-09-06/energy-trade-risks-collapsing-over-margin-calls-of-1-5-trillion#xj4y7vzkg