Article Post on 15 June 2019


_Amendments to 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 (“EMIR”) were made under Regulation (EU) 2019/834 of the European Parliament and of the Council (the "EMIR REFIT") and came into force on 17 June 2019.

The changes came following a review of EMIR undertaken by the European Commission that concluded that certain changes need to be made to simplify the clearing regimes and to make the clearing obligations more proportionate. Changes include the reduction in obligations for non-financial counterparties (“NFC”), a broadening of the scope of what is classed as a financial counterparty (“FC”), but then an introduction of concessions to a new category of “small financial counterparties” (“SFCs”).

While the EMIR REFIT extends the definition of FC to non-EU AIFs, this should be viewed more as a function of regulatory streamlining given the concession that is allowed under the new SFC regime.

Furthermore, the new SFC regime offers good news to  EU AIFs and UCITS that were previously subject to mandatory central clearing of over-the-counter (“OTC”) derivatives, but now may be able to avail themselves of the SFC definition where they fall below the clearing threshold triggers (described below) due to trading lower volumes of OTC derivatives, and therefore avoid the burden of central clearing requirements (but maintaining margin exchange obligations).

Summary of Changes

The EMIR REFIT includes wide ranging changes to the application EMIR, not all of which will be of immediate concern to fund managers. The key changes can be summarised as follows:

1. Extension of Scope of FCs

EU AIFs, regardless of whether their EU AIFM is authorised or registered are categorised as FCs unless they are set-up exclusively for the purpose of employee share purchase plans or as securitisation special purpose.

EU AIFs with a non-EU AIFM will now be categorised as FC (previously NFC) and non-EU AIFs with non-EU AIFMs will be classed as “third-country entity FCs”, which means that the rules will apply to them where they face an EU bank or broker. However, it is worth noting that the clearing thresholds that now apply to these firms reclassified as FC are the same as the previous NFC+/NFC- thresholds that could cause a NFC to be subject to mandatory clearing where it exceeded such thresholds.

UCITS management companies are now also captured by the wider definition of FC. However, UCITS themselves and MiFID investment firms were already captured, so this is unlikely to have any significant impact.

2. New Category of SFCs and Clearing Threshold Triggers

The EMIR REFIT introduced a new category of “small financial counterparties” which will be exempted from the obligation to clear their transactions through a central counterparty (CCP), while remaining subject to risk mitigation obligations and margin exchange for uncleared derivatives.

These SFCs are those that have lower volumes of OTC derivative trading activities and therefore fall below certain thresholds. In order to determine whether it qualifies as an SFC, an FC will have to calculate its aggregate month-end average gross notional value of OTC derivative transactions for the previous 12 months. If it exceeds any one of the gross notional value triggers for any class of OTC derivative then it must be classed as an FC.

In summary, the triggers for OTC equity and credit derivatives are each €1billion gross notional value, whereas the trigger is €3billion for interest rates, FX and commodities, which is as they were for the previous NFC+/NFC- regime. These calculation thresholds apply to all OTC derivatives that the entity enters into, whether cleared or uncleared, and regardless of whether they are entered into for hedging purposes.

The calculation must be performed annually. However, a firm may simply wish to class itself as an FC and then avoid the requirement to make the calculation.

Being considered an FC rather than an SFC will cause the entity to be subject to a clearing obligation for all of its OTC derivative contracts. The entity must notify ESMA and its relevant national competent authority of its being an FC and then make clearing arrangements within four months of that date (if classed previously as NFC+, an AIF managed by a non-EU AIFM should have already made these notifications). As such, the mandatory clearing obligation for these entities will apply from 18 October 2019 (however, it should be noted that the “frontloading” requirement is removed and therefore entities that become subject to mandatory clearing for new classes of derivatives do not need to clear any pre-existing transactions).

If the FC can (or wishes to) later demonstrate that its aggregate month-end positions for the previous 12 months do not exceed any of the triggers then it can notify and relieve itself of the clearing obligation by being classified as an SFC. Note, however, that SFCs remain subject to the rules on margin exchange for uncleared derivatives and risk mitigation under EMIR.

3. Extension of Clearing Exemption for Pension Scheme Arrangements

Of possible note to funds, but not direct applicability is the EMIR REFIT’s extension of the temporary exemption from the clearing obligation of pension scheme arrangements. This has been by another two years to 18 June 2021, subject to being further extendable by the Commission twice, each time by an additional year.

4. Changes to Reporting

The EMIR REFIT makes various changes to reporting obligations, many of which will not be applicable to EU AIFs or UCITS or their managers. One area of interest is that the EMIR REFIT amends the reporting obligation in respect of historic derivative transactions (the so-called “back-loading” obligation). Strictly speaking, firms should have been compliant with these provisions from 12 February 2019, but ESMA was aware of issues surrounding back-loading and therefore national competent authorities were not focusing on this area.

Removing the back-loading obligation will therefore provide relief to any firm that was not in technical compliance with the previous rules.

Action Required

AIFMs and UCITS managers should consider whether the SFC regime allows any of the AIFs or UCITS that they manage to fall within the SFC regime, by making the necessary calculations of aggregate month-end positions for the previous 12 months for each class of derivatives for each of the funds (or, in the case of legally segregated sub-funds, the sub-fund) that they manage. In doing so, they must ensure that these calculations do not lead to a systematic under-estimation of these positions or a circumvention of the clearing obligation (as there is a general anti-avoidance provision that is subject to monitoring by national competent authorities). 

Furthermore, non-EU AIFMs will need to review their existing derivatives documentation, such as any non-financial counterparty representation documentation, which will no longer be applicable upon re-classification from NFC to FC.

Our lawyers from the Investment Funds and Banking and Finance Practice Groups will be pleased to assist you with any such analysis.

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