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  • EU Agrees Final EMIR Refit
    On February 5, 2019, the Council of the European Union and the European Parliament reached a preliminary agreement on the draft Regulation amending the European Market Infrastructure Regulation, known as EMIR Refit or EMIR 2.1. The final text is likely to be published in the Official Journal of the European Union in April or May this year. Subject to a few exceptions, the changes will apply directly in all EU member states 20 days from that publication date. There may be minor drafting changes as the text is vetted by technicians and translated prior to its publication, but the legal position should be unaffected by this.

    New Financial Counterparty clearing threshold

    A clearing threshold is being introduced for the first time for Financial Counterparties, levelling the playing field somewhat for OTC derivatives between financial and non-financial parties and removing the potential for arbitrage as regards the FC / NFC definitions in EMIR. The threshold will be determined by taking into account all OTC derivative contracts entered into by a FC or entered into by other entities within the group to which that FC belongs based on the aggregate month-end average position for the previous 12 months. The FC clearing threshold will be the same as the existing NFC clearing thresholds. These are: 
    • €1 billion in gross notional value for OTC credit derivatives and OTC equity derivatives; and
    • €3 billion in gross notional value for OTC interest rate derivatives, OTC FX derivatives, OTC commodity derivatives and other OTC derivatives.

    Contrary to the NFC clearing obligation, once an FC exceeds the clearing threshold for one asset class (becoming an FC+), it will be required to clear all asset classes subject to the clearing obligation even if it does not pass the threshold for those other asset classes. The introduction of the clearing threshold for FCs changes the scope of the clearing obligation. The clearing obligation will apply to trades between: (i) two FC+s; (ii) an FC+ and an NFC+; (iii) two NFC+s; (iv) an FC+ or an NFC+ and a third-country counterparty that is equivalent to an FC+ or NFC+; or (v) two third-country entities established in a third country that would be subject to the clearing obligation if they were established in the EU, provided that the contract has a direct, substantial and foreseeable effect in the EU or where such an obligation is necessary or appropriate to prevent the evasion of any provisions of EMIR.

    Changes to the definition of the term "Financial Counterparty"

    EMIR Refit will amend the existing definition of FC, bringing central securities depositories authorized under the EU Central Securities Depositories Regulation within scope. In addition, the amended definition will categorize all alternative investment funds as financial counterparties, or, for non-EU funds, as third-country entities equivalent to FCs. This differs from the existing position where most AIFs treat themselves as non-financial counterparties or equivalent third-country entities. As a result of these changes, CSDs and their participants, AIFs, their managers and counterparties affected by the new FC definition will need to implement enhanced conduct requirements and amend their derivatives documentation to reflect their change of category. The introduction of a clearing threshold for all FCs will mean that smaller AIFs will not have to comply with all of the obligations that the new FC definition would otherwise have imposed on them.

    Amendment to the clearing obligation triggers

    EU counterparties will be required to clear OTC derivatives subject to the clearing obligation if they either: (i) do not calculate their average position to determine if they are over the clearing threshold; or (ii) do the calculation and determine that they are over the clearing threshold. This will apply to both FCs and NFCs.

    NFC clearing obligation

    EMIR Refit amends the NFC clearing provisions so that an NFC exceeding the clearing threshold (an NFC+) will only be required to clear the asset class for which it has exceeded the clearing threshold.

    Suspension of the clearing obligation

    The European Commission will have new powers temporarily to suspend the clearing obligation, on request from the European Securities and Markets Authority, for a specific asset class or type of counterparty. National regulators may submit a request to ESMA to do so. This may apply where either:
    • The class of OTC derivative is no longer suitable for central clearing; or
    • A CCP is likely to cease clearing that specific class of OTC derivative and no other CCP is able to clear that specific class of OTC derivative without interruption; or
    • It is necessary to avoid or address a serious threat to financial stability in the EU and that suspension is proportionate to that aim.

    Any such request will not be made public, but if the Commission suspends clearing then that decision will be published. A suspension will be for three months but could be extended for up to 12 months. If suspension of the clearing obligation is a “material change” under the Markets in Financial Instruments Regulation, then the related trading obligation under that separate regulation may also be suspended.

    Access to clearing services

    EMIR Refit introduces a new, and somewhat controversial, obligation for clearing members and clients to provide clearing services, whether they are provided directly or indirectly, under fair, reasonable, non-discriminatory and transparent (FRANDT principle) commercial terms. There is no need to contract to this effect. The Commission will adopt legislation setting out the conditions under which commercial terms are considered to be fair, reasonable, non-discriminatory and transparent. This new obligation will apply two years after EMIR Refit enters into force.

    Other changes
    • The frontloading requirement has been deleted so that, when the clearing obligation is triggered, there is no longer a requirement to clear pre-existing contracts.
    • The exemption from the clearing obligation for pension schemes will be extended for a further two years after coming into force of EMIR REFIT. That exemption period may be extended two more times for a further 12 months each. Pension schemes currently benefit from regulatory forebearance.
    • The reporting obligation remains mostly the same, except that:
      • The backloading requirement is removed. This obligation came into effect under EMIR on February 12, 2019 but ESMA stepped in again and market participants are benefitting from regulatory forebearance.
      • Responsibility for reporting has been clarified and a FC will become "solely responsible and legally liable" for reporting, on behalf of both counterparties, including in respect of details of trades entered into with an NFC. The FC must also ensure the accuracy of the reported details. A new obligation is imposed on NFCs to provide their FC with details of the OTC derivative trade that the FC cannot reasonably be expected to hold and the NFC will be responsible for ensuring those details are accurate. Where the FC is an EU AIF, the fund manager, regardless of their location or regulation, will be solely responsible and legally liable for reporting the OTC derivative contract. An NFC that already has a reporting system in place may continue to report its trades with an FC, provided that they inform the FC in advance. Where an NFC reports the trade, it shall be responsible and legally liable for reporting and ensuring the accuracy thereof. These provisions will apply 12 months after EMIR Refit enters into force.
    • To address issues about enforceability of the porting and leapfrog payment provisions in Articles 39 and 48 of EMIR under member state insolvency laws, an express provision that these Articles must prevail over any conflicting national insolvency laws is being added. The new provision will apply six months after EMIR Refit enters into force and will require modifications to be introduced to many member state insolvency laws.
    • A CCP will be required to provide its clearing members with a simulation tool to enable them to determine the gross amount of additional initial margin that the CCP may require when clearing a new transaction. A CCP must also provide its clearing members with information on the initial margin model that it uses. These new requirements will apply six months after EMIR Refit enters into force.
    • Some new obligations for trade repositories are also introduced, such as the obligation to provide non-reporting counterparties who have delegated their reporting duty with access to the information reported on their behalf and the requirement to have procedures in place for reconciling their data with that held by other trade repositories. Furthermore, ESMA's supervisory powers over trade repositories will be strengthened. 

    View the agreed text of EMIR Refit.

    View the Council's announcement.

    View details of ESMA's statement on the clearing obligation for pension schemes.

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