On 7 December 2022, the European Commission published a series of proposed measures to further develop the EU’s Capital Markets Union. These measures included proposed amendments to EMIR as part of a review known colloquially as “EMIR 3.0”. On 14 February 2024, following negotiation and political agreement with the European Parliament, the Council of the EU released the provisionally agreed text of EMIR 3.0. At the time of writing, we are awaiting formal approval by the European Parliament and the publication of the final legislation in the Official Journal of the EU in due course. EMIR 3.0 is currently expected to come into force in the second half of this year (although in many cases the obligations will not apply until details as to how counterparties should comply have been published by the European Securities and Markets Authority (“ESMA”) and finalised). Derivatives users should therefore now be reviewing their compliance arrangements, and considering whether and how EMIR 3.0 will require these arrangements to be amended and enhanced.
Transaction Reporting
There is an existing and continuing requirement in EMIR on transaction parties to report the details of all OTC and exchange-traded derivative contracts that they conclude, modify or terminate to a trade repository by the end of the next working day. From 29 April 2024 and separately to EMIR 3.0, significant changes will be made to the transaction reporting rules applicable to derivatives users. You can read more about this here.
EMIR 3.0 contains new requirements in relation to data quality and penalties for transaction reporting. Derivatives users will be required to put in place appropriate procedures and arrangements to ensure the quality of data reported. ESMA will be mandated to draft guidelines to specify these procedures and arrangements. In addition to existing penalties requirements under EMIR, national competent authorities (such as the Central Bank of Ireland (the “CBI”)) will be obliged to impose administrative or periodic penalty payments on entities whose reports repeatedly contain manifest errors. The periodic penalties will be set at an amount up to 1% of average daily turnover for the proceeding business year per day of breach. While many national competent authorities (including the CBI) have reserved the right to issue fines for EMIR transaction reporting breaches, this is the first time a quantifiable financial penalty for breach of transaction reporting requirements will be enshrined in the primary legislation. ESMA will be mandated to draft Regulatory Technical Standards specifying what constitutes specific manifest errors for this purpose.
EMIR 3.0 will also introduce a new transaction reporting requirement for non-financial counterparties (“NFCs”) subject to the clearing obligation (“NFC+s”) whose intragroup trades have until now been eligible for an exemption from transaction reporting requirements. Such NFC+s may still benefit from the existing transaction reporting exemption for all NFCs with regard to intragroup transactions. However, where it has an EU parent, the parent will have to report to its competent authority the net aggregate positions of the NFC+ per class of derivatives on a weekly basis.
Since the coming into force of EMIR in 2012, the CBI has issued a number of guidance statements and recommendations in relation to EMIR. For example, in its EMIR reporting letter of 20 February 2019, the CBI recommends that compliance with the transaction reporting rules under EMIR should be a standing agenda item at all board meetings for Irish entities trading derivatives. Moreover, in its third Securities and Markets Risk Outlook Report published on 2 March 2023 the CBI stressed that it expects derivatives users to "have appropriate oversight of data reporting from Board level down (including where data reporting is outsourced)". In particular, the CBI expects formalised policies and procedures to be in place to ensure compliance. On 28 November 2023, the CBI issued a fine against a fund for breaches of the transaction reporting rules under EMIR following an enforcement action pursuant to the European Union (European Markets Infrastructure) Regulations 2014, as amended - you can read more about this here.
Given this background, the new transaction reporting rules which will apply from 29 April 2024 and now the forthcoming new requirements in relation to transaction reporting in EMIR 3.0, we have seen a number of our clients putting in place formal EMIR compliance policies which are approved at board level. These policies cover compliance with the EMIR transaction reporting rules, as well as compliance with EMIR more generally.
Clearing
One of the central objectives of EMIR 3.0 is to encourage clearing in the EU and improve the attractiveness of EU authorised CCPs. Furthermore, EMIR 3.0 aims to strengthen EU strategic autonomy and safeguard financial stability by requiring clearing members and clients to hold directly or indirectly an active account at EU authorised CCPs. Financial counterparties (“FCs”) subject to the clearing obligation (“FC+s”) and NFC+s who exceed a threshold of €3 billion when all OTC interest rate derivatives denominated in euro and / or Polish zloty and short term interest rate derivatives denominated in euro (“SSI Derivatives”) are aggregated at group level will be obliged to hold at least one active account for SSI Derivatives in an EU authorised CCP. These entities must also clear a 'representative' number of trades in such active accounts if they exceed a threshold of a notional clearing volume outstanding of €6 billion when all their SSI Derivatives are aggregated. Further details of these requirements are to be developed by ESMA. It is important to note that these obligations will not directly impact most buy-side derivatives users as they are not FC+s or NFC+s.
Intragroup Exemptions
EMIR allows exemptions from certain of the clearing and mandatory margining requirements for OTC derivatives transactions between counterparties in the same group. Where the group counterparty is a third country entity, one of the conditions to availing of the exemptions is that an "equivalence" decision has been made by the European Commission to the effect that the third country's legal and supervisory regimes are equivalent to the relevant requirements laid down in EMIR. To date, no equivalence decisions have made in respect of clearing and only a limited number of equivalence decisions have been made in respect of mandatory margining. This means that where the group counterparty is a third country entity, the parties typically need to avail of the separate and temporary cross-border intragroup derogations and comply with the conditions relating to same in order to be exempt.
In EMIR 3.0, the requirement for an equivalence decision will be removed for the purpose of the cross-border intragroup exemptions from the clearing and mandatory margining requirements for OTC derivatives transactions. It will be replaced by a requirement that the counterparty is not in a "high risk" jurisdiction which either has deficiencies in its anti-money-laundering or counter-terrorist regime or is on the EU list of non-cooperative tax jurisdictions. The European Commission may also on an ad hoc basis identify other jurisdictions that should not benefit from the intragroup exemptions. It is hoped that the removal of the equivalence decision requirement for cross-border intragroup exemptions from the clearing and mandatory margining requirements will materially simplify the intragroup exemption framework and put these exemptions on a more definite and permanent footing.
Other Changes to EMIR
EMIR 3.0 also contains a number of other amendments to the EMIR framework. These include the following:
- EMIR 3.0 will amend the scope of the derivatives that must be included in the aggregate positions to be measured against the clearing thresholds for NFCs – these amendments will apply following the entry into force of Regulatory Technical Standards on clearing thresholds which ESMA will be mandated to prepare. These amendments will be beneficial from the perspective of NFCs by allowing them to exclude derivatives that are cleared through an EU authorised CCP or EU recognised CCP. Moreover, while EMIR currently requires NFCs to count all OTC derivatives entered into by any NFC entity within the group, EMIR 3.0 will restrict the count to uncleared OTC derivatives entered into by the NFC itself. NFCs will continue to be able to exclude derivatives which are objectively measurable as reducing risks directly relating to the commercial or treasury activity of the NFC itself or the group to which it belongs.
- EMIR requires counterparties to uncleared derivatives to post variation margin, and where their volumes of trading exceed set thresholds, to post initial margin. To date there has been a time-limited exemption / forbearance from mandatory margining in the case of certain equity derivatives. EMIR 3.0 will introduce a permanent exemption from mandatory exchange of initial and variation margin for uncleared single stock equity options and equity index options.
- EMIR 3.0 will give NFCs who become subject to mandatory margin requirements, including requirements to post variation margin and initial margin, a new 4-month implementation period to set up the relevant arrangements to meet these obligations. During this period any new derivatives entered into will be exempt from the mandatory margin requirements.
- EMIR 3.0 will introduce a permanent exemption from clearing for EU counterparties who are over the clearing thresholds where they enter into transactions with third country pension schemes where those schemes are authorised, supervised and recognised under national law and are within the scope of a clearing exemption in their home jurisdiction.
- EMIR 3.0 will require clearing members of CCPs to enable their clients to predict the likelihood of margin calls, particularly during stress events. Clearing members will be required to explain to clients how cleared margin models work, including simulations showing the implications for their clients during periods of market stress. Further details of these requirements are to be developed by ESMA.
We are continuing to keep a close eye on developments in this area and will publish further updates as matters progress. For further information on EMIR 3.0, on putting in place formal EMIR compliance policies or on EMIR compliance more generally, please contact Richard Kelly, Alan Bunbury or your usual Matheson contact.
This article is provided for general information purposes only and does not purport to cover every aspect of the themes and subject matter discussed, nor is it intended to provide, and does not constitute or comprise, legal or any other advice on any particular matter.