knowledge 2 May 2024 |

EMIR 3: Update on implementation

The final texts are expected to be announced in the new European Parliament Plenary in the autumn and to receive subsequent final sign-off from the EU Council. It is anticipated that EMIR 3 will come into effect some time in Q4 of 2024.

EMIR 3 will enter into force on the twentieth day following its publication in the Official Journal of the European Union, with most provisions expressed to apply from its entry into force, save for certain provisions amending the clearing thresholds, which are expressed to apply from entry into force of related regulatory technical standards.

Background

The stated aim of EMIR 3 is to mitigate excessive exposures to third-country central counterparties as well as improve the central clearing system in the EU, making EU central counterparties (“CCPs”) more efficient and attractive.

The Commission had previously expressed concerns about the possible financial stability risks associated with the reliance of EU financial markets on UK CCPs. Commissioner McGuinness noted that Brexit was a “fragmenting event, with consequences in terms of financial stability. UK-based CCPs now operate outside of the Single Market and the EU's regulatory framework and over-reliance on these CCPs implies financial stability risks, notably in the event of stress”. 

In addition, the Commission has highlighted the difficulties posed by the energy crisis and, in particular, the need to address challenges certain energy firms face in order to meet CCP margin calls. EMIR 3 is intended to address both of these concerns by enhancing the attractiveness of EU CCPs and increasing transparency of margin models and collateral requirements.

Active Account Requirement

One of the key reforms under EMIR 3 includes the introduction of an active account requirement. It would require in-scope financial counterparties (“FCs”) and non-financial counterparties (“NFCs”) that are subject to the EMIR clearing obligation (“NFC+”), to hold, directly or indirectly, active accounts at EU CCPs and clear a specified proportion of their derivative contracts through an EU CCP.

Who is in scope?

The active account requirement will apply to FCs and NFCs that are subject to EMIR clearing obligations and that exceed the clearing threshold in any of the in-scope categories of derivatives contracts. The clearing threshold can be exceeded in respect of an individual category or on aggregate basis across all listed categories.

The in-scope counterparties will need to hold at least one active account at an EU CCP and clear, unless otherwise exempt, at least a representative number of trades in that active account. The in-scope counterparty will need to establish an active account within six months of becoming subject to the obligation.

What products are in scope?

The active account requirement will apply in respect of trades in derivatives which are deemed to be of substantial systemic importance. Currently those derivatives are (i) interest rate derivatives denominated in euro and Polish zloty, and (ii) Short-Term Interest Rate Derivatives denominated in euro.

The initial EMIR 3 proposal  had also included credit default swaps denominated in euro in the category of derivative contracts subject to the active account requirement, as per European Securities and Markets Authority’s (“ESMA”) conclusion that the clearing of such credit default swaps was of substantial systemic importance to the EU or one or more of the EU member states.  The amended EMIR 3 now excludes reference to the credit default swaps, in light of recent market developments.

The list of contracts subject to the active account obligation may be amended by the European Commission. This, however, will be subject to ESMA issuing a thorough and comprehensive cost-benefit analysis and an opinion concluding that  it is necessary to amend the list of contracts.

What are the operational elements of the active account requirement?

In-scope counterparties will need to ensure that:

1. the account is permanently functional, meaning that relevant legal documents, IT connectivity and internal processes are in place;
2. they have systems and resources available to be operationally able to use the account, even at short notice, for large volumes of in-scope derivative contracts; and
3. all new trades in respect of in-scope derivative contracts can be cleared in the account at all times.

In-scope counterparties will need to fulfil the above requirements within six months of becoming subject to the active account requirement as well as stress-test the requirements at least once a year.

Counterparties that clear at least 85% of the in-scope derivative contracts at an EU CCP are exempt from the operational elements of the active account requirements as well as from the requirement to clear on annual average basis at least five trades in each of the most relevant subcategories per class of derivative contracts and per reference period (discussed in more detail below).

What are the clearing obligations in respect of the active account requirement?

In-scope counterparties will need to clear in the active account a representative number of trades in EU CCPs. The representativeness obligation will be assessed according to the different classes of derivative contract, the maturity of the trades and the trade sizes.

For the representativeness obligation to be fulfilled, in-scope counterparties will need to clear on annual average basis at least five trades in each of the most relevant subcategories per class of derivative contracts and per reference period. ESMA is charged with setting the duration of the reference period, which shall not be less than six months for counterparties with a notional clearing volume outstanding of less than €100 billion in the in-scope derivative contracts and not less than one month for counterparties with a notional clearing volume outstanding of more than €100 billion.

The representativeness obligation, however, will not apply to the provision of client clearing services and to counterparties with a notional amount outstanding cleared of less than €6 billion in the in-scope derivative contracts.

Further, EMIR 3 proposes that a scaled-down representativeness obligation should be established for specific EU pension schemes, such that only one trade would be required to be cleared instead of five in the most relevant subcategories per reference period. This would be relevant to EU pension scheme arrangements that have a limited number of interest rate derivatives trades, which are concentrated, long-term and with a high notional amount.

Are there reporting obligations in respect of the active account requirement?  

In-scope counterparties will need to calculate their activities and risk exposures in the categories of in-scope derivative contracts and report every six months to its competent authority (for Irish in-scope counterparties this will be the Central Bank of Ireland) to demonstrate compliance with the active account requirement. The information reported to the competent authority will need to demonstrate that the legal documentation, IT connectivity and internal processes associated with the active accounts are in place.

Other proposed changes under EMIR 3

The EMIR 3 proposal includes a number of other proposed amendments including:

• a permanent exemption from regulatory margin requirements for non-centrally cleared single-stock equity options and equity index options (see our recent briefing on the current position in this regard here);
• an exemption from the clearing obligation for transactions resulting from post-trade risk reduction exercises;
• an exemption from the clearing obligation for FCs or NFCs that would otherwise be subject to that obligation where transacting with a third-country pension scheme that meets certain conditions;  
• amendment of the NFC clearing threshold methodology so that it is determined by reference only to trades that are centrally cleared with an EU authorised or recognised CCP, with the hedging exemption continuing to be determined by reference to risk reduction effects at group level;
• retention of the NFC intragroup reporting obligation exemption and introduction of a requirement that the EU parent undertaking of any NFC+ relying on this exemption make certain weekly reports on the NFC+’s positions to the parent’s EMIR national competent authority;
• a 4 month implementation period for an NFC becoming subject to the EMIR margin requirement and daily mark-to-market requirement for the first time, to facilitate establishment of relevant arrangements;
• restriction of the range of counterparties to which initial margin model validation requirements will apply, with the EBA being tasked with operating as a central validator of industry-wide, pro-forma margin models (e.g. ISDA SIMM);
• replacement of equivalence pre-conditions to the availability of the intragroup transaction exemptions from clearing and bilateral margining requirements, where one party is established in a third country, with mechanisms for excluding certain third countries from the ambit of the exemptions; and
• removal of equivalence as a pre-condition to the NFC- exemption from reporting OTC derivatives.

EMIR Refit – Now in force

Changes made to EMIR by EMIR Refit¹  (see our briefings here and here) mandated the development of new technical standards regarding the information to be reported to trade repositories.  The revised standards, which were published by the European Commission in October 2022 (here), have now come into effect as of 29 April 2024. 

While these changes do not change the responsibility for reporting², they do:

• significantly impact the substance and form of the required reports on a go-forward basis, with a considerable expansion of potential data field inputs;
• impose an obligation to re-report outstanding derivative contracts in accordance with the applicable new requirements within 180 calendar days of the changes taking effect – 26 October 2024 - or in any earlier report of the relevant contract (e.g. due to a modification of its terms or a reporting correction); and
• introduce an express requirement for the responsible reporting entity to notify relevant EMIR national competent authorities of certain types of material errors or omissions in its reporting.

Given the serious consequences of failure to comply with EMIR reporting obligations (see here), it is essential that all responsible reporting entities and reporting delegates comply or, as applicable, monitor compliance, with the new requirements.

Also contributed to by Artur Pokhilo