EMIR Briefing: The Essentials for Fund Managers
What is EMIR?
The European Market Infrastructure Regulation ("EMIR") is a European legal initiative introduced to improve transparency, mitigate counterparty credit risk and bring increased stability to the market in financial derivative instruments ("FDI"). It is relevant to all Irish funds trading in FDI, whether on an exchange or otherwise.
Key Aspects of EMIR
There are three main strands to the obligations under EMIR as set out below. EMIR also establishes a framework for the establishment and regulation of two entities that will support the FDI market, namely central clearing counterparties ("CCPs") and trade repositories ("TRs").
|Aspect of EMIR||Type of instruments covered||Requirements||Current status|
|Clearing||Over-the-counter (“OTC”) derivatives||For certain OTC transactions, CCP will have to be appointed, with the fund's counterparty risk passing from its trading counterparty to that intermediate CCP (which in turn will require sufficiently liquid margin to secure the exposures arising from those positions).||Rules will (we anticipate) be introduced from Q1/Q2 2015 onwards, on a phased basis by class of FDI.|
|Reporting||All derivatives||Funds must report certain prescribed details of all derivatives transactions to a regulated entity, the TR, which then collates that information and makes it available to the authorities.||Rules now in effect|
|Risk mitigation||Uncleared OTC derivatives||EMIR introduces myriad obligations in respect of dispute resolution, frequency of valuations and reconciliations of OTC contracts, processes for ensuring key trade terms are properly defined by parties. Rules on the segregation and quality of collateral as well as capital requirements to cover any margin of risk not covered by collateral are pending.||Most requirements now in effect|
Staged Implementation – EMIR Timeline
Q. What is your EMIR classification?
The scope of applicable EMIR requirements varies depending on the entity's EMIR counterparty classification.
An Irish authorised UCITS or AIF (with an authorised or registered AIFM) will be a financial counterparty ("FC") for the purposes of EMIR.
An Irish authorised AIF that benefits from the transitional period for AIFMD1 (for example, a QIF with a third country AIFM that has not registered with a regulator) will be classified as a non-financial counterparty ("NFC") for the purposes of EMIR and may be a non-financial counterparty plus ("NFC+") if (excluding hedging transactions) its gross notional exposure to OTC derivatives exceeds the relevant clearing thresholds.
Q. Are the instruments you are trading in-scope FDIs?
The scope of FDI for the purposes of EMIR is by way of cross-reference to the Markets in Financial Instruments Directive2 ("MiFID"). This includes swaps, options, futures, forwards and contracts for difference. There is uncertainty in relation to whether a currency spot with a longer settlement period could be classified as a currency forward. Pending further clarification on this from the European Securities and Markets Authority ("ESMA"), the current guidance from the Central Bank of Ireland (the "Central Bank") on this point is that: (i) all currency transactions with settlement beyond seven days should be reported; and (ii) the reporting of currency transactions with settlement between three and seven days should not be considered obligatory, but parties should nevertheless report these where systems are in place to do so.
Q. Is the Central Bank the Irish Competent Authority for EMIR yet?
Yes. A statutory instrument was published on 10 October 2014 designating the Central Bank of Ireland as the national competent authority in Ireland for the purposes of EMIR3.
Q. What is the impact on ISDA documentation?
As well as publishing a number of useful guidance notes, ISDA has issued the following documents to address EMIR obligations: (i) a template reporting delegation agreement; (ii) portfolio reconciliations, depute resolution and disclosure protocol; (iii) timely confirmations supplemental wording; and (iv) NFC Representation protocol. Where parties elect to adhere to the protocols on the ISDA website, certain amendments will be incorporated into the adhering parties' ISDA Master Agreements or other agreements governing derivative transactions in order to facilitate compliance with EMIR.
Q. What is the first class of FDI to be affected by the clearing rules once introduced?
The first classes affected will be interest rate swaps and credit default swaps on certain European indexes.
Meeting the EMIR Challenge
Fund managers must adapt to this regime to minimise its impact on their investment strategy and cope with the significant changes it requires to how derivatives are traded, from a legal and operational perspective.
Investment management agreements and trading agreements should be reviewed to ensure responsibility is properly assigned for obligations introduced – for example, to identify which counterparty will take care of the reporting obligation and whether the fund's investment manager will ensure the OTC risk mitigation techniques are observed. IT systems and reporting capabilities will need to be enhanced to meet new reporting, record keeping and risk mitigation requirements. In addition, central clearing will inevitably require significant operational changes, and necessitate adequate provision for sufficiently liquid margin.
If you would like further information on EMIR or would like to discuss the potential implications for your business and the recommended measures to ensure adherence with the provisions of the EMIR, please contact your usual Maples and Calder contact.
3S.I. 443 of 2014; European Union (European Markets Infrastructure) Regulations 2014