EMIR Margin Rules - ESAs publish proposed amendments

Overview

On 5 December 2019, the European Supervisory Authorities¹  (ESAs) published this Final Report (Report) on amendments to the bilateral margin requirements set out in EU Delegated Regulation 2016/2251²  on risk mitigation techniques for uncleared OTC derivative contracts (Margin Rules). The Report contains draft regulatory technical standards (RTS) proposing the following amendments to the Margin Rules:

• changes to the phase-in of initial margin (IM) requirements such that:
  1. the 1 September 2020 Phase 5 implementation would apply to firms with an average aggregate notional amount (AANA) of between €50 billion and €750 billion (rather than between €8 billion and €750 billion, as is currently the case); and
  2. a new Phase 6 would be introduced on 1 September 2021, for firms with an AANA of between €8 billion and €50 billion;
• the introduction of an "opt-out" from variation margin (VM) requirements applicable to physically-settled FX swaps and physically-settled FX forwards except where both counterparties are credit institutions or investment firms under the Capital Requirements Regulation (CRR)³, or third-country equivalents;
• an extension until 21 December 2020 of the temporary exemption from the requirement to post IM for intragroup transactions where one counterparty is a third-country entity and no equivalence decision has been made; and
• a one-year extension (until 4 January 2021) of the temporary exemption available under the Margin Rules for single-stock equity options and index options. 

The Report also includes:

• a clarification that documentation, custodial and operational arrangements are not required to be made if the IM to be transferred is under the €50 million threshold; and
• a statement⁴ from the ESAs indicating that they expect national competent authorities to exercise regulatory forbearance between now and finalisation of the RTS.

The RTS will now be reviewed by the European Commission, the European Parliament and the Council. Once they are agreed, the final form of the RTS will be published in the Official Journal of the European Union and will enter into force the following day.

Change to Initial Margin phase-in timetable

The current timeline for the phase-in of IM requirements under the Margin Rules mirrors the implementation calendar⁵  agreed by the Basel Committee on Banking Supervision (BCBS) and the International Organisation of Securities Commissions (IOSCO) in September 2013. The original calendar comprised five "phases", with the largest and most active market participants becoming subject to IM requirements on 4 February 2017 (phase 1), and subsequent phases starting on 1 September in each consecutive year until the fifth and final phase, starting on 1 September 2020.

This calendar has subsequently been amended, most recently in July 2019⁶, such that the outstanding phase-in dates are now as follows:

• 1 September 2020 (phase 5) - entities with an AANA of between €50 billion and €750 billion will become subject to the IM requirements; and
• 1 September 2021 (new phase 6) - entities with an AANA of between €8 billion and €50 billion will become subject to the IM requirements.

The amendments set out in the RTS would amend the Margin Rules to reflect these changes to the BCBS-IOSCO calendar.

In response to market speculation that the lowest, €8 billion, threshold might be increased, the Report specifically states that "no change of the thresholds, in particular the 8 billion threshold, are envisaged". It also confirms that no further extension of the phase-in timetable is expected.

Clarification of requirements where Initial Margin is below €50 million threshold

In September 2018, various trade associations wrote⁷ to the BCBS and IOSCO setting out concerns that the IM implementation phases 4 and 5 - scheduled for 1 September 2019 and 1 September 2020 respectively - would bring an unnecessarily large number of relatively smaller counterparties into scope of the IM rules, and that the increased regulatory burden could dissuade them from entering into risk-mitigating transactions. The letter also noted that many of these entities would not in practice be required to transfer any IM in any case, as the IM amount would be below the €50 million threshold set out in the Margin Rules.

Six months later, in March 2019, the BCBS and IOSCO published guidance⁸ in which they note that "the framework does not specify documentation, custodial or operational requirements if the bilateral initial margin amount does not exceed the framework's €50 million initial margin threshold.". Rather than proposing amendments to the Margin Rules to reflect this guidance, in the Report the ESAs say that this clarification can already be taken into account when applying the requirements of the Margin Rules and that such amendments are therefore not required.

Notwithstanding the lack of legislative change, EU market participants will be able to take comfort from this statement by the ESAs and rely with more certainty on the BCBS-IOSCO guidance.

Carve-outs for physically-settled FX swaps and forwards

Under the Margin Rules, in-scope entities may choose to "opt out" of collecting IM in respect of physically-settled FX forwards and physically-settled FX swaps. VM, however, must be posted in respect of physically-settled FX swaps and (since MiFID II⁹ came into force on 3 January 2018) physically-settled FX forwards.

Following market consultation, in November 2017 the ESAs made a statement¹⁰  in which they effectively said that VM was not in fact required for physically-settled FX forwards, and that national competent authorities should "apply their risk-based supervisory powers in their day-to-day enforcement of applicable legislation in a proportionate manner" (i.e. exercise regulatory forbearance) in this area. The reason for this was twofold: (1) recognition of the fact that the Margin Rules are broader in scope than corresponding rules in other jurisdictions, which do not mandate the posting of VM for physically-settled FX forwards, and (2) at the time of the statement, EMIR¹¹, which underlies the Margin Rules, was under review and was expected to be amended to "de-scope" these products.

The result of the EMIR review was EU Regulation 2019/834¹² (the Refit Regulation), which included a Recital proposing that VM requirements in respect of both physically-settled FX forwards and physically-settled FX swaps be restricted to transactions between the most systemic counterparties.

The RTS would amend the Margin Rules to effect this proposal, such that VM would only be required for physically-settled forwards and physically-settled swaps where both counterparties were CRR credit institutions or investment firms.

Extension of Initial Margin exemption for intragroup transactions with a third-country counterparty

The Margin Rules currently provide for temporary exemptions from IM and VM requirements for intragroup transactions involving a third-country counterparty (Third-Country IGTs) where no equivalence decision has been made in respect of that third country. The rationale for this is that Third-Country IGTs should not become subject to such requirements until an equivalence decision has been made under EMIR, as the equivalence decision is a pre-requisite for targeted (conditional) exemptions. The existing temporary exemptions are due to expire on 4 January 2020.

The RTS contain an amendment extending the IM temporary exemption until 21 December 2020 – the same extension as has been granted in respect of the clearing obligation applicable to such transactions. During this time it is hoped that the necessary equivalence decisions will be made by the European Commission, allowing the transactions to benefit from the exemptions available under EMIR. There is no corresponding amendment extending the temporary exemption available in respect of VM, although this appears to be an oversight that is expected to be rectified during the review process.

Extension of exemption from Initial Margin and Variation Margin for single-stock equity options and index options

The Margin Rules currently provide for a temporary exemption, until 4 January 2020, from IM and VM requirements for single-stock equity options and index options. The exemption was included to avoid market fragmentation and regulatory arbitrage, as many other jurisdictions do not require IM or VM to be transferred in respect of such products. The delayed implementation was intended to provide time to monitor global regulatory developments and ensure that the EU requirements did not differ materially from those of other jurisdictions. The proposed amendment would extend the temporary exemption by one year, to 4 January 2021. According to the Final Report, the rationale for this is to allow further monitoring of the situation globally, with a view to re-considering the temporary nature of the exemption at a later date.

"Forbearance" statement

Several of the proposed amendments to the Margin Rules will not take effect before the issues that they are designed to address arise (for example, expiry of the temporary exemptions for Third-Country IGTs and single-stock and equity options). The Report comments that the ESAs cannot disapply EU law, but goes on to say that the ESAs expect national competent authorities to "apply the EU framework in a risk-based and proportionate manner until the amended RTS enter into force". This is the standard formulation of wording used by the ESAs when requesting that competent authorities exercise regulatory forbearance in certain areas, so market participants can rely on this statement when considering their positions and actions as regards the matters covered in the Report.

Next steps

The RTS have been sent to the European Commission for review. Once endorsed by the Commission, they will be considered by the European Parliament and the Council and, once agreed, will be published in the Official Journal of the European Union. They will enter into force the following day.

Authors: Jonathan Haines and Kirsty McAllister-Jones

1. The European Securities and Markets Authority (ESMA), the European Banking 2. Authority (the EBA), and the European Insurance and Occupational Pensions Authority (EIOPA).
2. Margin Rules
3. EU Regulation 575/2013 on prudential requirements for credit institutions and investment firms.
4. "The ESAs expect competent authorities to apply the EU framework in a risk-based and proportionate manner until the amended RTS enter into force".
5. September 2013 Implementation Calendar
6. July 2019 revised Implementation Calendar
7. Trade Associations' letter
8. March 2019 Guidance
9. The second Markets in Financial Instruments Directive
10. ESAs November 2017 statement on VM
11. The European Market Infrastructure Regulation
12. Refit Regulation