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Trading derivatives? Don't forget about your EMIR duties (September 30, 2013)

The European Market Infrastructure Regulation (EMIR) introduced many new duties that parties’ trading OTC derivative contracts (OTC Traders) must comply with. Those duties are gradually entering into force. Therefore, each OTC Trader should keep close track of the EMIR timeline.

Currently, OTC Traders must apply the so-called risk mitigation techniques (RMTs). In order to comply with RMTs, OTC Traders need to amend and supplement contractual arrangements with their counterparties and put certain mechanisms in place. The scope of RMTs that apply to a particular OTC Trader depends on the status of that OTC Trader. Financial counterparties (banks, investment funds, insurance companies, etc.) and non-financial counterparties exceeding EMIR thresholds (€1 billion for OTC credit derivative contracts and for OTC equity derivative contracts, €3 billion for OTC interest rate derivative contracts, for OTC foreign exchange derivative contracts, for OTC commodity derivative contracts and all other OTC derivative contracts) must apply all RMTs. Non-financial counterparties falling below EMIR thresholds need only apply a limited number of RMTs.

The following RMTs apply to all OTC Traders:

  • Timely confirmation. OTC Traders must confirm all derivative contracts. Confirmation means the documentation of the agreement of the OTC Traders to all the terms of a contract.
  • Portfolio reconciliation. OTC Traders are required to reconcile their un-cleared portfolios. The portfolio reconciliation must cover key trade terms of each derivative contract.
  • Dispute resolution procedures. OTC Traders must agree on and maintain detailed dispute resolution procedures.
  • Portfolio compression. An OTC Trader with 500 or more derivative contracts outstanding with its counterparty that are not centrally cleared must have in place procedures to regularly analyze whether to conduct a portfolio compression exercise.

 

The following RMTs apply only to financial counterparties and non-financial counterparties exceeding EMIR thresholds:

  • Monitoring value of outstanding contracts. OTC Traders must have procedures for monitoring the value of outstanding contracts on a daily basis (mark-to-market).
  • Segregated exchange of collateral. OTC Traders must apply risk-management procedures requiring the timely, accurate and appropriate segregation of exchange of collateral with respect to derivative contracts.

 

OTC Traders can comply with portfolio reconciliation and dispute resolution procedures in one of the following ways:

1.         ISDA 2013 EMIR Portfolio Reconciliation, Dispute Resolution and Disclosure Protocol

The most convenient way for OTC Traders with multiple counterparties to comply with these obligations is by adhering to the ISDA 2013 EMIR Portfolio Reconciliation, Dispute Resolution and Disclosure Protocol (Protocol). By adhering to the Protocol, the OTC Traders amend and supplement their derivative contracts with those counterparties that also adhered to the Protocol. The Protocol covers not only the ISDA agreements but all derivative contracts covered by EMIR. Over 6,000 OTC Traders adhered to the Protocol as of September 30, 2013.

2.         ISDA Standard Amendment Agreement

The OTC Traders may also choose to bilaterally enter into the ISDA Standard Amendment Agreement - 2013 EMIR Portfolio Reconciliation, Dispute Resolution and Disclosure Form. This is more appropriate for OTC Traders entering into agreements with only few counterparties.

3.         Separate Amendment

Finally, the OTC Traders may enter into their “own” amendment to their derivative contracts.

This is only a very brief overview of OTC Traders’ current obligations under EMIR. Implementation of EMIR obligations is a comprehensive process. We are happy to provide you with more details upon request.