1. What is EMIR?

1.1. Key regulations and supporting documentation

The following sub-sections breakdown the key regulations and supporting documents you need to be aware of.

1.1.1. The European Market Infrastructure Regulation

This regulation, No 648/2012, was adopted by the EU on 4 July 2012 and came into force on 16 August 2012, with immediate effect as explained above, along with the main features of this regulation.

1.1.2. ESMA’s regulatory and implementing technical standards

EMIR required ESMA to draft Regulatory and Implementing Technical Standards (RTS and ITS) to further detail and and aide in implementing the provisions of EMIR. These standards cover:

  • Details of the data to be reported to Trade Repositories
  • Details of the application for registration of a Trade Repository
  • Data to be published by the trade Trade Repositories and operational standards
  • Colleges for CCPs
  • General requirements and prudential requirements for CCPs
  • Clearing obligation, risk mitigation techniques and NFCs
  • The provisions of EMIR together with the deadlines included within the different technical standards imply a phased-in
  • implementation of the legal framework.

1.1.3. ESMA’s Q&As on EMIR

The purpose of this document is to promote common supervisory approaches and practices in the application of EMIR. It provides responses to questions posed by the general public, market participants and competent authorities in relation to the practical application of EMIR.

1.1.4. The European Commission’s FAQs on EMIR

This document gives answers to questions on EMIR that have been raised, following the publication of EMIR in the Official Journal of the EU, on the following topics:

  • The timing of the implementation
  • The scope of the requirements
  • The position of third country CCPs and trade repositories
  • The FAQs are designed to provide clarity on these three topics from the Commission services. They are not an authoritative interpretation of Union legislation.

1.2. Scope of EMIR

EMIR places obligations on any EU entity or EU regulated entity that enters into derivative contracts. This includes both financially regulated entities and unregulated entities. EMIR also has some extra territorial reach as it applies to transactions in OTC derivatives which have a “substantial, foreseeable and significant effect in the Union”.

So what entities have obligations under EMIR?

EMIR introduces entity classifications which we must become familiar with:

  • Counterparty
  • Financial Counterparty (FC)
  • Non-Financial Counterparty (NFC)
  • Significant Third Country entity (STC)
  • Non-Financial Entity (NFE)
  • Third Country Entity (TCE)
  • Central Counterparty (CCP)
  • Individuals (not subject to EMIR)

1.2.1. Entities

1.2.1.1. Financial Counterparties

A financial counterparty is defined in EMIR Article 2(8) as any of the following:

  • investment firm authorised under Directive 2004/39/EC ;
  • credit institution authorised under directive 2006/48/EC ;
  • insurance undertaking authorised under Directive 73/239/EEC ;
  • assurance undertaking authorised under Directive 2002/83/EC ;
  • reinsurance undertaking authorised under Directive 2005/68/EC ;
  • UCITS and, where relevant, its management company;
  • authorised under Directive 2009/65/EC;
  • institution for occupational retirement provision within the meaning of Article 6(a) of Directive 2003/41/EC ; or
  • alternative investment fund managed by AIFMs authorised under Directive 2011/61/EU

Identification of Financial Counterparties

In order to be classified as a financial counterparty, the entity must be authorised under one of the above directives, as opposed to being authorised under the national law of a member state. Furthermore, it must be established that the entity concerned does not fall within any of the exemptions of the specific directives or those exemptions existing within the text of EMIR (exemptions are set out below):

Authorised investment firmsESMA now maintains a register of authorised MiFID entities. Other competent National authorities are also required to maintain a publicly available register of authorised investment firms. For example, the FCA maintains a register on its website.

Authorised credit institutions – a register is available on the European Banking Authority website of all credit institutions to which authorization has been granted to operate within the European Union and European Economic Area countries (EEA).

Authorised AIF managed by an AIFMESMA maintains a central public register of all AIFMs authorised under AIFMD.

Authorised institution for occupational retirement provision – in the UK context this will, for practical purposes, mean all tax approved funded pension schemes. Elsewhere, registers may be maintained by national competent authorities, but these may not be publicly available.

Authorised insurance, assurance, reinsurance undertakings and UCITS – For UCITs undertakings ESMA maintains a list. Other registers may be maintained by national competent authorities, but these may not be publicly available.

It should be noted that non-EU firms may be authorised within the EU by one of the directives specified above and as such may be appropriately categorised as an FC. This means the following will have a reporting obligation under EMIR where they enter into a derivative contract (taking on the legal and commercial risks of the contract). Any company, partnership or other undertaking established within the EU.

Municipalities and Regional Governments

ESMA has recommended that the Commission considers issuing guidance on the applicability of EMIR to Municipalities and regional governments, i.e. whether Article 1(4)(a) should apply to their municipalities, or whether Article 1(5)(b) should apply and some NCAs consider that municipalities are not undertakings and are therefore automatically out of scope.

Sub-funds

Sub-funds that sit under an Umbrella fund would be the counterparty to a transaction and therefore must reported as such with an appropriate LEI code.

1.2.1.2. Non-Financial Counterparties

A non-financial counterparty is defined in EMIR Article 2(9) as an undertaking established in the Union, which is not a financial counterparty.

Thus, an entity which is established within the EU but is not authorised under one of the relevant directives will be an NFC provided that it is an “undertaking” and is “established in the EU”. Unfortunately, there is no guidance within EMIR regarding the meaning of “undertaking” or “established in the EU” and as a consequence an entity could potentially be determined to be an NFC in any of the following conditions.

  • It is incorporated in EU
  • Its primary place of business in the EU
  • It is branch in the EU of an entity incorporated outside the EU
  • It is a Non-EU branch of an EU NFC
  • Its management and control is in the EU
  • It is tax resident in EU
  • It is a government body engaging in commercial or economic activity
  • It is a partnership
  • It is an SPV
  • It is an individual operating a business for which the derivative trading activity is in relation to

Individuals would generally be out of scope however, if the trading is in relation to an economic business activity, day trading, operating as a local, hedging as a sole trader then the activity would be captured and have to be reported by the individual. The individual must apply for an LEI for reporting purposes.

Is it a Non-Financial Counterparty+ (NFC+)?

“NFC+” is the term used in the industry (it is not a term used in EMIR) to describe a non-financial counterparty that takes positions in OTC derivative contracts and those positions when added to the unhedged derivative positions of the other Non-Financial Entities in its accounting group exceed the clearing threshold specified in the RTS pursuant to Article 10. The clearing thresholds apply to OTC contracts and are set per class and by gross notional value:

EUR 1 billion:

  • Credit derivatives
  • Equity derivatives

EUR 3 billion:

  • Interest rate
  • Foreign exchange
  • Commodity
  • Others

In order to calculate whether it exceeds the clearing thresholds, an NFC shall include all the OTC derivative contracts entered into either by itself or by other “non-financial entities” within the group to which that non-financial counterparty belongs. However, it does not include in its calculation the OTC derivative contracts which are objectively measurable as reducing risks directly related to its commercial activity or treasury financing activity or that of its group (For guidance on the definition of “group”, please refer to ANNEX I – Defining “group” under EMIR).

The term “non-financial entity” is not defined within EMIR, but is clearly intended to be a broader category than NFC, requiring consideration of the derivative positions of group members globally not just those within the EU. Thus, a decision regarding whether an NFC exceeds the clearing threshold, mandates an aggregate calculation across all global entities considered within the scope of non-financial entities.

The key is to identify those NFCs (or those entities that would be NFCs if established in the EU) within the group who carry out proprietary business on an unhedged basis. If those entities have gross unhedged derivatives exposure exceeding a clearing threshold, then we will be able to conclude that all NFCs within the group as a whole should be considered as an NFC+ for the purposes of Article 10(3). As the threshold will already have been breached for Article 10(3) purposes it will not be necessary to then go through any other trades of the wider group.

1.2.2. Products

Unfortunately, there is no simple answer as to what products are within the reporting scope of EMIR – what has to be reported is a function of:

  • The product
  • The role played by each entity
  • The status of the entities involved in the trade
  • The nature of the event itself

We have therefore broken this question down and addressed it below.

1.2.2.1. What Contracts Have To Be Reported?

Contracts concluded between counterparties must be reported

ESMA give a definition of conclusion of a contract within their technical standards which states that conclusion of a contract has the meaning of execution of a transaction under MiFID. This however, does not reflect the way in which the reporting obligation has been implemented. In practice, where you or a client is the legal counterparty to a contract then a reporting obligation may arise where the contract is in respect of an instrument in scope.

Reporting Scenarios

We have identified a number of scenarios in the section below. Within each we have highlighted where there is a contract between the parties which is subject to the reporting obligation (on the basis the instrument is a reportable instrument).

Trades with client

Often clients will seek to take positions in respect of on exchange derivatives and even bilateral derivative positions. This is normally achieved by entering into a back to back contract with the client which mirrors the on exchange or OTC contract entered into by their broker.

Agency activity

Trades undertaken as agent, i.e. on behalf of a client where the counterparty risk is borne by the client are not reportable by the agent. They may however, be reportable by the client where the client is an entity subject to EMIR (either as an FC, and NFC or as a CCP).

Where the client has the reporting obligation, its reports should identify as its counterparty the party it is legally contracting with. The difficulties are exacerbated as the client would also have to ensure that it was in receipt of the necessary identifiers for the trade including the UTI.

1.2.3. Reporting Scenarios

1.2.3.1. Electronic Execution (Non-Allocated)

For any trade executed on an electronic platform, both parties should use the UTI generated by the electronic platform if available, otherwise they should default to the next available point of the trade flow for determination, i.e. Middleware or Paper flow.

1.2.3.2. Electronic Execution (Allocated)

If the trade is allocated over a platform (electronic direct allocation) can generate the UTI for each allocation and notify both Parties, then this can be used. The platform over which the trade is allocated may not be the same as that upon which it was executed.

Where a trade is allocated off-platform (or the platform cannot generate a UTI), then the Dealer allocating the trade will generate the UTIs and notify the buy-side of the references via the communication process.

1.2.3.3. Broker/Direct Submission to Middleware, Affirm in Middleware

There is no central generation of UTI at point of execution. Both parties agree the trade with a broker and the broker inputs into Middleware or, the trade is agreed bilaterally and input by one side into Middleware. Both Parties affirm the trade in the Middleware system. Middleware system will generate a UTI which will be shared and consumed by both parties to the trade.

1.2.3.4. Confirm Matched in Middleware

There is no central generation of UTI at point of execution. The trade is either done by a Broker, or bilaterally agreed between Counterparties. Trade details are sent to Middleware by Parties A and B for matching.

Middleware generates a UTI when the first trade is submitted. If the subsequent submission matches, then the UTI will be shared and consumed by both Parties. Once matched, the Middleware will determine the correct UTI and notify both Parties who will need to consume, and if applicable, update their reference to match.

In the occasional instance where trades get confirmed via Middleware or an electronic confirmation platform which does not offer UTI generation or reporting services, the UTI generation guidelines for paper confirmed trades would apply.

1.2.3.5. Paper Trades

There is no central execution and no Middleware for confirmation matching; trades will be paper confirmed. If the other party receives the agreed UTI before the reporting deadline, then they should also include the UTI on their confirmation. However, if the other Party has not received an agreed UTI before the reporting deadline, they may submit their own trade reference, but not report a UTI until a UTI is agreed, at which time they should update and report with the agreed, final UTI. To determine who generates the UTI when there is no central execution platform.

In the example below, Party B is the UTI generator:

1.2.3.6. Affirm In Middleware (Cleared Trade Example)

There is no central generation or exchange of UTI at point of execution. One Party/Broker alleges the trade in the Middleware system for the other Party to accept. Middleware system will generate a UTI, which will be shared and consumed by both parties to the trade.

Alpha

Beta/Gamma

1.2.3.7. Unlinked Principal Trades

The following diagrams are intended to generically represent common flows for cleared swaps for purposes of communicating the UTI. Not all flows will apply to all asset classes, nor will all CCPs support all flows.

For simplicity of illustration, the cleared trade scenarios show reporting to one TR, however, it is possible that reporting could occur to separate TRs.

New Trade

The Unlinked model implies no linkage between the two cleared sides.

Allocated Trade
The following is a pre-clearing scenario:

Portfolio Transfer
The trade between parties is agreed & already has a UTI (UTI1, UTI2). The portfolio is now being transferred from Clearing Member 1 to Clearing Member 3.

Compressions
In a compression, multiple trades exist and have been cleared. The original trades are closed per Client request by executing a new trade in an offsetting position to the original trade. In a full compression, no residual amount remains after netting, so no new trade arises (e.g, no new UTI generated). Both original trades are terminated. In a partial compression, a residual amount remains after netting, and a new trade for the remnant is created with a new UTI. The compressed original trades are terminated.

A partial compression, which is a post-clearing event, is shown here. In a full compression, new UT15 and new UT16 would not be generated.

1.2.3.8. Novations Over Middleware

The trade between the original Parties is agreed and already has a UTI.

In the case of creation of a new UTI, a reference to a prior UTI will be required.

1.2.3.9. Novations on Paper

Work flow is the same as for paper trades. UTI needs to be shared as part of the confirmation process. Upon novation, the party responsible for generating the UTI creates it. The UTI needs to be shared as part of the confirmation process.

1.2.4. Instruments

Any financial derivative is subject to the EMIR reporting regime. Financial derivatives are listed and defined under Annex 1 Section C of MiFID I. Generally, you know one when you see one.

1.2.4.1. Spot Transactions

These are not reportable. Typically, a spot transaction is any transaction where:

  • settlement takes place within 2 days of entering into the trade; or
  • for commodities where settlement takes place within a period customary for the product traded (this is because of the challenges of the physical delivery)

1.2.4.2. FX Derivatives

In the implementation of MiFID I in the UK FX derivatives that were used for commercial purposes (typically to convert transactions into major currencies) would not be classed as financial derivatives under MiFID. This meant that firms settling equity transactions in USD and at the same time locking in their sterling value by using an FX forward would not be treated as having transacted a financial derivative. PERG 13.4 states the following will not be classified as a financial derivative:

  • forward foreign exchange instruments unless caught by scope of the Regulated Activities Order (RAO);
  • a non-deliverable currency forward that is not a ‘future’ for the purposes of the RAO because it is made for commercial purposes; and
  • spot transactions in both foreign exchange and commodities

This is contrary to the view applied in other parts of Europe and under ESMA’s guidance which will treat any FX product where settlement is more than 2 days following entry into the transaction as a financial derivative and therefore reportable under EMIR. So there will be potentially non-reportable FX transactions for UK firms.

1.2.4.3. Commodities

Spot contracts
A spot contract for the sale of a commodity, asset or right, under the terms of which delivery is scheduled to be made within the longer of the following periods:

  1. two trading days;
  2. the period generally accepted in the market for that commodity, asset or right as the standard delivery period
  3. there is no understanding between the parties that the delivery will be postponed beyond the period above (i.e., delivery will take place as in (1) and (2) above)

Physically settled gas and power forwards
Physically settled gas and power forwards that are traded on multilateral trading facilities (MTFs) are ‘financial instruments’ for the purposes of MiFID, but are ‘OTC derivatives’ or ‘OTC derivative contracts’ for the purposes of EMIR. This means that the venue field must be XXXX within the EMIR report.

Indices
When reporting indices, the validations applied under EMIR restrict what can be reported. Where the instrument is OTC or is an ETD listed outside of Europe the interim taxonomy must be used. As such commodity index would be reported as follows:

Details S&P GSCI Bloomberg Commodity Index
Type of instrument Commodity index future Commodity index future
Where traded CME CBOT
Delivery type C (for cash) C (for cash)
Trading Venue XXXX XXXX
Taxonomy used E (interim taxonomy) E (interim taxonomy)
Product ID 1 CO CO
Product ID 2 FU FU
Commodity base IN (for Index) IN (for Index)
Commodity details OI (Oil the major component as only one type can be reported) OI (Oil the major component as only one type can be reported)
Underlying Blank (as a commodity instrument) Blank (as a commodity instrument)