EMIR Margin Rules Proposal

On 28 July 2016, the EU Commission wrote to the European Supervisory Authorities (the "ESAs"), stating its intention to endorse with amendments the draft Regulatory Technical Standards which set out the rules on exchange of collateral for non-cleared OTC derivatives required by Article 11 of EMIR (the "Margin Rules"), published by the ESAs on 8 March 2016 (the "ESA draft RTS"). The Commission's amendments include revised phase-in dates for the application of the initial and variation margin requirements, as well as clarification of the application dates for intragroup contracts where equivalence decisions are pending.

Initial margin

Under the revised timeline, derivative contracts will become subject to the EMIR initial margin requirements when both counterparties to the transaction have, or belong to groups which have, an aggregate notional amount of non-centrally cleared derivatives above the threshold amount - the "IM Notional Amount Threshold" - applicable on the relevant phase-in date. The revised dates specified in the Commission's proposals for application of the requirements for collection of initial margin and the thresholds over which OTC derivative contracts will be caught are as follows:

*Note that this threshold reflects the addendum published by the Commission on 2 August 2016, correcting certain errors in its original draft.

Variation margin

The revised timeline also provides that derivative contracts become subject to the EMIR variation margin requirements when both counterparties have, or belong to groups which have, an aggregate notional amount of non-centrally cleared derivatives above the threshold amount - the "VM Notional Amount Threshold" - applicable on the relevant phase-in date.

The revised dates for application of the requirements for collection of variation margin and the thresholds over which OTC derivative contracts will be caught are as follows:

** Note that the original draft contained an error in the operation of this threshold, which was corrected in the Commission addendum published on 2 August 2016.

The ESA draft RTS had proposed a first phase-in date for variation margin requirements of 1 September 2016 to those counterparties above a VM Notional Amount Threshold of EUR 3 trillion. Under the Commission proposals the first application date of the variation margin requirements will not be clear until the date the RTS comes into force is known (see "Next Steps and Indicative Timeline" below).

Intragroup contracts

The provisions in the ESA draft RTS governing the application dates of the initial margin requirements to intragroup contracts where one party is outside the EU were somewhat unclear, and the Commission amendments make necessary clarifications. Where a derivative contract meets the definition of an intragroup contract under Article 3 of EMIR, and where one counterparty is outside the EU (or the European Economic Area (the "EEA") once EMIR applies across the EEA), the initial margin requirements will apply as follows:

Where no equivalence decision has been made in respect of the third country's margin requirements under Article 13(2) of EMIR, three years after the date the RTS enter into force.

Where such an equivalence decision has been made, the later of the following:

1. 60 days after the equivalence decision comes into force; and
2. the date the initial margin requirements would otherwise come into force according to the table under "Initial Margin" above.

Whilst this amendment allows counterparties a grace period during which an equivalence decision may be made enabling a contract with a counterparty outside the EU to be deemed an intragroup contract, there may still be logistical difficulties with obtaining an intragroup exemption within 60 days from an equivalence decision coming into force.

The provisions above are expressed only to apply to initial margin requirements. The Commission appears to have withdrawn any grace period for the application of variation margin requirements to intragroup contracts with counterparties in third countries. As the Commission proposals stand, variation margin requirements would apply to intragroup contracts with counterparties in third countries on the dates given in the table under "Variation Margin" above, regardless of an equivalence decision being made or pending.

FX forwards

The ESA draft RTS provided for a delayed application of the requirement to exchange Variation Margin for physically settled FX forwards until such time as those contracts are properly defined when the relevant delegated act under MiFID II comes into force, expected on 3 January 2018, with a back-stop date of 31 December 2018 applying if that delegated act is not in force by then.

The Commission has now made an additional provision in its proposals that if the entry into force of the Margin RTS is delayed beyond the entry into force of the MiFID II delegated act, FX forwards will be brought into scope as soon as the variation margin requirements begin to apply.

Equity options

The Commission has confirmed and clarified that the initial and variation margin requirements will apply to non-centrally cleared single stock equity options or index options from three years after the date the RTS come into force. The rationale given is that these contracts are not subject to margining in some other jurisdictions, and a phase-in is required in order to ensure that appropriate requirements are in place to mitigate against possible credit risk for such contracts whilst avoiding scope for regulatory arbitrage.

Next steps and indicative timeline

The ESAs have six weeks in which to amend the draft RTS on the basis of the Commission's amendments and re-submit it in the form of a formal opinion to the Commission.

If, by the end of the six-week period, the ESAs have not submitted an amended draft of the RTS or have submitted a draft that is not consistent with the Commission's amendments, the Commission may then either adopt the RTS with the amendments it considers relevant or reject the RTS.

Effectively this means that at this stage of the process, the Commission's amended draft is likely to be the version adopted by the Commission. Adoption is likely to be in six weeks' time, although it may be earlier if the ESAs accept the amendments made by the Commission and produce their opinion earlier in the six-week period.

If the ESAs submit an opinion reflecting all of the Commission's amendments, so that the Commission adopts a version of the RTS which is the same as the draft submitted by the ESAs, the European Parliament and the Council can object within one month from the date they are notified of the Commission's adoption of the RTS, although either Parliament or the Council can extend that period by a maximum of two months.

However, if the ESAs submit a version which does not reflect the amendments made by the Commission, the Commission can adopt its own version or reject it entirely. In this case, Parliament and the Council have a period of three months from the date of notification of adoption by the Commission. That period can be extended by Parliament or by the Council for a further three months.

At the end of that period for objection, if there is no objection from Parliament or the Council, the adopted RTS will be published in the Official Journal of the European Union and will come into force 20 days later. If the ESAs accept all of the Commission's amendments and if the above periods are neither extended nor shortened, the RTS would come into force around November 2016. This means that the first variation margin requirements could apply from a date in December 2016.

The indicative timeline below summarises these processes, although note that dates are necessarily approximate, and each stage may be shortened.

Other commission amendments

Whilst the format of the RTS has changed significantly from the ESA draft RTS, the Commission has made relatively few substantial changes. It has, however, amended the rule in the ESA draft RTS that initial margin in cash must be held with a central bank or credit institution authorised in accordance with the Capital Requirements Directive. The Commission proposals also allow initial margin collected in cash to be held with banks which are authorised in a third country whose supervisory and regulatory arrangements have been found to be equivalent in accordance with the Capital Requirements Regulation ("CRR"). There is no general equivalence provision for authorisation purposes under the CRR. However there are various provisions for equivalence in CRR for various purposes, including provision for equivalence decisions to be made under Article 107 of CRR with respect to the application of capital requirements for exposures to institutions in third countries, and we assume that this is what the Commission has in mind.