Legal development

EU EMIR - European Commission proposes reform

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    On 7 December 2022, as part of a Capital Markets Union package of reforms relating to clearing, listing and corporate insolvency, the European Commission proposed wide-ranging reforms to EU EMIR .1

    The proposed amendments include:

    • a requirement for EU entities subject to the clearing obligation to clear a proportion of certain types of transaction through an EU CCP (commonly referred to as the "active account requirement");
    • the introduction of a four-month implementation period for non-financial counterparties coming into scope of the margin rules for the first time;
    • removal of the reporting exemption applicable to intragroup transactions involving a non-financial counterparty or third-country equivalent;
    • removal of the requirement for an applicable equivalence decision to be in place for an exemption to be granted in relation to an intragroup transaction with a third-country entity;
    • replacement of the requirement described above with a requirement that the third country not be a "blacklisted" jurisdiction;
    • deletion of the provision (Article 13) that permits substituted compliance;
    • changes to the clearing threshold calculation methodology so that only transactions that are not cleared through an appropriate CCP are taken into account;
    • a requirement for ESMA to review and clarify the clearing thresholds applicable to non-financial counterparties;
    • a requirement for ESMA to review and clarify the clearing "hedging exemption" criteria; and
    • an exemption from the clearing obligation for transactions with third-country pension scheme arrangements that are exempted under domestic law.

    The European Parliament and the Council will now review the proposals, and may suggest amendments. The review process is expected to take several months, so we are unlikely to see changes to EU EMIR in the short term.

    The UK government has not proposed corresponding amendments to UK EMIR and has indicated that its primary legislative focus at present is tabling amendments to other major pieces of financial legislation, including the UK Prospectus Regulation regime and the UK PRIIPs Regulation.

    In this briefing we consider some of the key proposed reforms to EU EMIR and the impact they might have.

    New "active account" obligation – minimum activity level

    A key element of the proposal is a requirement for EU market participants that are subject to the EU EMIR clearing obligation to clear a proportion of the following categories of transactions through an EU CCP:

    • euro or Polish zloty-denominated interest rate derivatives;
    • euro-denominated credit default swaps; and
    • euro-denominated short-term interest rate derivatives.

    The stated aim of this proposal is to reduce financial instability by limiting EU entities' exposure to systemically important non-EU CCPs (also known as Tier 2 CCPs2), although it will in practice have the added advantage of increasing the level of derivatives clearing in the EU. Entities which are subject to the rule would also need to calculate and report the level of trading activity cleared through an EU CCP and confirm compliance with the applicable thresholds. 

    Further requirements are proposed pursuant to which entities providing clearing services would need to inform their clients that certain contracts can be cleared through an EU CCP.

    These obligations will start to apply twenty days after the amending regulation is published in the Official Journal, but the exact proportions referred to above and the calculation methodology will be established thereafter under level two legislation. It is not clear from the proposal whether or how impacted entities are to ensure compliance before the level two rules are finalised. If the intention is for affected entities to have an active EU CCP account operational within twenty days of the amending regulation being published, this will be a challenging timeframe in which to establish the necessary clearing arrangements. Market participants should therefore start preparing for this change in advance of its implementation.

    This proposal could have commercial implications for market participants, as the changes may require them to amend their clearing strategies and transfer existing transactions from a UK CCP to an EU CCP. The additional regulatory reporting and client information elements may also require adaptations from an operational perspective. 

    Margin rules - four-month implementation period for NFCs

    Under EU EMIR, there is no grace period for entities when they become subject to the margin rules for the first time, so they must comply from the date on which they first come within scope. This can be problematic, as it can take a significant amount of time and resource to put in place the required documentation and establish the necessary operational arrangements. 

    In the proposal, the Commission recommends introducing a four-month grace period for non-financial counterparties (NFCs) that cross the clearing threshold and become NFC+ entities. The period would start on the date of the NFC's notification of its "+" status, and would give the NFC+ time to put in place the relevant documentation and margining arrangements. During the four-month period, the NFC+ would remain exempt from the margin requirement. The amendment would align the margin implementation timeline for NFC+s with the clearing implementation timeline, which also has a four-month grace period. No corresponding changes have been proposed for newly in-scope financial counterparties (FCs). This is unhelpful as there are certain circumstances, such as mergers, where this could be relevant.

    This would be a welcome development, but market participants may consider that four months is too short a period in which to establish appropriate arrangements and that a longer timeframe would be of more practical benefit. This would be felt most acutely where initial margin is required, as the necessary arrangements are complex and involve third-party custodians.

    The same section of the proposal says that ESMA may issue future guidelines or recommendations to ensure a uniform application of the risk-management procedures. There is some uncertainty in the market as to the interpretation of EU rules relating to firms' AANA3 calculation, and in particular whether newly in-scope firms should calculate based on the most recent March, April and May or based on the forthcoming March, April and May. ESMA guidance in this area would be very welcome, particularly if it confirmed the latter approach to be correct.

    Reporting obligation – removal of intragroup exemption

    The EU EMIR reporting obligation does not currently apply to intragroup transactions involving an NFC or a third-country equivalent NFC, subject to certain requirements. In the proposal, the Commission recommends removing this exemption, on the basis that it limits ESMA's visibility of the risks taken by NFCs. The proposal explains that intragroup transactions' interconnectedness with the rest of the financial system and recent strains on energy markets warrant more visibility in respect of these types of transaction. However, the removal of this exemption would significantly increase the reporting burden on NFCs within corporates, and related costs.

    Intragroup exemption regime – replacement of equivalence requirement with blacklist restrictions 

    Under EU EMIR, intragroup transactions can be permanently exempted from clearing and margining where certain criteria are met. One such criterion is that, where the transaction is between an EU entity and a non-EU affiliate, the non-EU entity is established in a jurisdiction in respect of which the EU has determined that the rules are equivalent to corresponding rules under EU EMIR. Such determinations are currently made under Article 13 EU EMIR. 

    The Commission recommends deleting Article 13 and replacing the requirement for an equivalence determination with a regime under which transactions involving a counterparty established in certain jurisdictions would not be able to benefit from an intragroup exemption. The proposed "blacklisted" jurisdictions are those listed: 

    1. by the Council as non-cooperative tax jurisdictions; and
    2. under EU Directive 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing as a high-risk third county that has strategic deficiencies in its anti-money laundering and counter-terrorist financing regimes.

    The proposed amendments would also allow the Commission to add further countries to the list of banned jurisdictions, giving the Commission broad powers to expand the prohibition in the future.

    Article 13 of EU EMIR also permits substituted compliance, so that counterparties to derivative transactions are deemed to have fulfilled their EU EMIR obligations if one of them is established in an equivalent third country. A number of full and partial equivalence determinations have already been made under Article 13, including in respect of the United States. If Article 13 were to be removed, the substituted compliance regime, which is relied on by many market participants, would no longer apply. This consequence is not addressed in the proposal and may be an oversight, so it is possible that this part of the proposal will be amended so that Article 13, or certain elements, are retained.

    Clearing threshold calculation methodology – non-cleared transactions only

    FCs and NFCs currently determine whether the clearing threshold has been exceeded, and consequently whether certain obligations apply, by calculating their aggregate month-end average OTC derivative position for the previous twelve months for each applicable asset class. If any of the thresholds is exceeded, the entity is classified as an FC+ or an NFC+.

    The Commission has proposed a change to this calculation methodology, such that only OTC derivative transactions that are not already cleared through an authorised or recognised CCP need to be included. The rationale here is that transactions that are already cleared pose a reduced risk and therefore need not be taken into account when determining which obligations apply.

    This would be a welcome change for market participants as it would mean fewer entities categorised as FC+ or NFC+ and therefore fewer market participants subject to mandatory clearing. It will be particularly welcome if the "active account" requirement discussed above is implemented.

    Clearing – review and clarification of NFC clearing thresholds and hedging exemption

    Following the recent increase in the commodity derivatives clearing threshold from EUR 3bn to EUR 4bn, the amending regulation may give rise to further changes - but only for NFCs. If adopted, the amending regulation would require ESMA to review the clearing thresholds applicable to NFCs at least every two years to (i) ensure that they are still appropriately calibrated and (ii) ascertain whether further asset classes should be added.

    ESMA will also be required to review the so-called hedging exemption, which allows NFCs to exclude from their threshold calculations transactions which are objectively measurable as reducing risk.

    Clearing – exemption for transactions with certain third-country pension scheme arrangements

    A further amendment to the clearing obligation would permanently exempt transactions between an EU entity and a non-EU pension scheme arrangement that is exempted from clearing in its home jurisdiction. This would ensure that EU EMIR is aligned with similar regimes in other jurisdictions and avoid regulatory arbitrage by market participants.

    EU EMIR review – postponed

    EU EMIR requires the Commission to report on the regulation's application generally by 18 June 2024 and on certain other matters by 17 June 2023. The amending regulation would postpone the 2024 review until five years after the amending regulation enters into force and remove the requirement for the 2023 review entirely.

    AuthorKirsty McAllister-Jones

    1. EU Regulation 648/2012.
    2. Being, at the time of writing, LCH Limited and ICE Clear Europe Limited.
    3. Aggregate average notional amount.
    The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to.
    Readers should take legal advice before applying it to specific issues or transactions.

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