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Information about new European regulation on OTC derivatives

Paragraphs

EMIR (European Market Infrastructure Regulation or Regulation No 648/2012 of the European Parliament and of the Council of 4 July 2014 on OTC derivatives, central counterparties and trade repositories) is directly applicable EU regulation, which establishes common rules for OTC derivatives transactions, for risk mitigation techniques related to the above-mentioned transactions and for reporting of such transactions. EMIR entered into force on 16 August 2012. Different implementing regulations will come into force gradually during 2013 and 2014.

Objectives of EMIR

EMIR was adopted as a result of the 2009 decision by G20 to regulate OTC derivatives market in more detail, with the objective of increasing the transparency of derivatives market and lowering systemic risk in the global financial system caused by derivatives transactions. EMIR is one of the regulatory acts the European Union is using to implement these objectives.

Area of influence

Requirements of EMIR apply to OTC derivatives transactions, among them also to some of the transactions that can be concluded under SEB Financial Markets Client Agreement – including interest rate derivatives and FX derivatives (forwards, swaps, options). EMIR requirements apply both to financial and non-financial counterparties. Requirements of EMIR do not apply to private individuals and certain government institutions.

Main requirements of EMIR

  • Obligation to report derivatives transactions to a Trade Repository;
  • Obligation to centrally clear transactions with certain OTC derivatives through a Central Counterparty (CCP);
  • Mandatory risk mitigation techniques for non-cleared derivatives transactions.


Obligation to report derivatives transactions to a Trade Repository

Obligation to report transactions applies to all counterparties of the derivatives transactions, only private individuals are excluded. It means that both counterparties to the derivatives transaction must report the transaction, modifications to the transaction and termination of the transaction to a licensed trade repository selected by them. The reporting obligation may also be delegated to the other counterparty or to a third party. The transaction has to be reported no later than the first business day after the day of the transaction conclusion, modification or termination of the transaction.

As stipulated in the SEB’s Derivatives Trading Agreement, SEB will also report the derivatives transactions to a trade repository on behalf of its  clients, except when the client notifies the bank about its choice to report such transactions independently or there are some other reasons preventing SEB from reporting on behalf of the client.

In transaction reports the counterparties to the transaction must be identified by the Legal Entity Identifier (LEI), which is a new identifier being used globally to identify counterparties to the financial transactions. Until LEI format and issuing principles are finalized, an "interim" LEI code (or pre-LEI) must be used.

Obtaining LEI (or any equivalent identifier) is the responsibility of a counterparty to the derivatives transaction. If a client has not obtained LEI (or any equivalent identifier), it might not be possible for SEB to report the transactions on behalf of the client and therefore such client might be required to report the transactions itself. SEB can also refuse to conclude new derivatives transactions with such clients who are not assigned the LEI. Clients may be assigned the LEI (or an interim LEI) by any organization assigning the LEI (e.g. from the USA - webpage www.ciciutility.org or from Germany – www.geiportal.org etc). Costs related to assigning and maintaining the LEI (or any equivalent identifier) have to be borne by the client.

The reporting obligation is expected to come into force on 1 January 2014. In addition to the new transactions concluded from the above date, all derivatives transactions open from 16 August 2012 or concluded after said date must be also reported.

The clearing obligation applies to transactions with the standardized OTC derivatives. Instruments covered by such obligation will be announced on ESMA (European Securities and Markets Authority) webpage http://www.esma.europa.eu. The clearing obligation of the first type of the derivatives instruments is expected to come into force in 2014 or 2015.

The clearing obligation applies to financial counterparties and to non-financial counterparties exceeding the so-called clearing threshold. The clearing thresholds have been set so that only the companies having very large speculative positions in derivatives might exceed them (e.g. a company exceeds the threshold if it has a speculative position in interest rate derivatives with the nominal value of more than 1 billion euros or a speculative position in FX derivatives with the nominal value of more than 3 billion euros). The clearing thresholds are calculated on the level of the group of companies instead of the legal entity level.

Starting from 15 March 2013, companies exceeding the clearing threshold will have to notify the relevant regulatory authority and ESMA about it (they also have to notify when they have fallen back below the threshold). Transactions must be cleared only when the clearing obligation applies to both counterparties to the trade.

To clear a transaction, the counterparties must become members of a licensed central counterparty (CCP) or use the services of a CCP member or its client. Clearing means that the parties, who originally conclude a derivatives transaction, give-up the transaction to CCP so that CCP becomes a counterparty to both original parties to the trade.

Main risk mitigation techniques influencing non-financial counterparties:

  • Timely confirmation of transactions. EMIR establishes the deadlines for confirming transactions depending on the counterparty and the instrument type. Transactions concluded with SEB under the Derivatives Trading Agreement are confirmed timely as SEB considers the transactions to be confirmed if its counterparty does not notify SEB of any errors on the confirmation within 24 hours from the confirmation receipt.
  • Portfolio reconciliation. Parties to the derivatives transaction have to agree on a regular transaction reconciliation process to identify any discrepancies. EMIR establishes periodicity of the portfolio reconciliation based on the counterparty type and the number of open transactions between counterparties. To reconcile portfolios in terms of the transactions concluded under the SEB’s Derivatives Trading Agreement, SEB will regularly send statements to clients on the outstanding transactions.  If the client does not notify SEB of any errors in the statement, SEB considers such portfolio to be reconciled. The portfolio reconciliation with non-financial counterparties who have less than 100 derivatives transactions outstanding with SEB must to be performed once a year.
  • Dispute resolution. Counterparties to the derivatives transaction must agree on a dispute resolution process. SEB has established the dispute resolution process in the Derivatives Trading Agreement.

Different EMIR requirements will be applied depending on classification of a counterparty – whether counterparty is financial or non-financial counterparty and in the latter case it will also depend on the type, purpose and amount of the transaction concluded by the counterparty. Classification of the counterparties under EMIR differs from the client classification under MiFID. Financial counterparties under EMIR are considered to be banks, investment firms, insurance companies, fund management companies etc. All other entities are considered to be non-financial counterparties. Under the SEB’s Derivatives Trading Agreement clients must notify SEB about the changes of their categorization. If the client fails to notify SEB, SEB will consider the client concluding derivatives transactions under SEB Derivatives Trading Agreement to be a non-financial counterparty below the clearing threshold. AB SEB bankas is considered to be a financial counterparty under EMIR.

Additional information:

More information on the regulatory changes under EMIR and Q&A for market participants on practical implementation of EMIR is available on ESMA EMIR website: www.esma.europa.eu/page/European-Market-Infrastructure-Regulation-EMIR