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Derivatives Obligations laid down in EMIR: Risk mitigation techniques for non-centrally cleared contrats

Risk mitigation techniques for non-centrally cleared contrats

Published on December 4, 2015

The following requirements apply to all counterparties, whether financial or non-financial, who trade a derivative contract, absent an applicable exemption.

Confirmation of trades in OTC contracts (effective since 15 March 2013)

EMIR requires that the terms of OTC derivative contracts not cleared by a CCP be confirmed rapidly, where possible, using electronic means. The confirmation is a legally binding agreement covering all the terms of an OTC derivative contract.

Confirmation deadlines are laid down in the technical standards and set out in the following table. 

Confirmation deadlines for OTC transactions
Counterparty 1  Counterparty 2 Derivative  Date  Final confirmation deadline
Financial or non-financial above mandatory clearing threshold

Financial or non-financial above mandatory clearing threshold

 

 

 

CDS/interest rate swaps

 

 

 

Equities/foreign exchange/commodities and other

Before 28 Feb 2014

After 28 Feb 2014

 

From 31 Aug 2013 to 31 Aug 2014

After 31 Aug 2014

2 days

 

1 day

 

 

2 days

 

1 day

Financial or non-financial Non-financial below mandatory clearing threshold

CDS/interest rate swaps

 

 

 

Equities/foreign exchange/commodities and other

From 31 Aug 2013 to 31 Aug 2014

After 31 Aug 2014

 

From 31 Aug 2013 to 31 Aug 2014

After 31 Aug 2014

3 days

 

 

2 days

 

 

4 days

 

 

2 days

 

Daily marking to market of OTC contracts (effective since 15 March 2013)

Current contracts entered into by financial counterparties must be marked to market daily. Where market conditions mean this is not possible , a reliable and prudent mark-to-model valuation may be used.

Portfolio reconciliation (effective since 15 September 2013)

Operators and their counterparties must reconcile their portfolios. More specifically, this consists of reconciling portfolios of contracts in such a way as to identify any discrepancies in the material terms of all their trades (contract value, maturity, payment and settlement dates, etc.).

The objective is to identify any disagreement over material terms of OTC derivatives as early as possible. Such reconciliations must be carried out:

> for financial or non-financial counterparties above the mandatory clearing threshold:

  • daily when counterparties have 500 or more OTC derivative contracts with each other
  • weekly for portfolios of between 51 and 499 dérivatives
  • quarterly for portfolios of 50 derivatives or fewer

> where one of the counterparties is non-financial and below clearing thresholds:

  • quarterly for portfolios of 100 or more dérivatives
  • annually for portfolios of fewer than 100 dérivatives

Dispute resolution (effective since 15 September 2013)

When entering into an OTC derivative contract, the counterparties (whether financial or non-financial) must agree on detailed procedures and processes for the following:

  • the identification, recording and monitoring of any disputes over the recognition or value of contracts or the exchange of collateral between the parties (meaning all collateral in the form of cash or financial instruments tendered by counterparty A to counterparty B to protect counterparty B should counterparty A prove unable to honour its commitments)
  • the timely resolution of such disputes, with a special procedure that must be agreed between the parties for disputes continuing longer than five working days

Furthermore, financial counterparties must report disputes concerning amounts in excess of €15 million (contract value or amount of collateral to be exchanged) and lasting longer than 15 days to the AMF.

Portfolio compression (effective since 15 September 2013)

The process of portfolio compression between two counterparties consists of identifying positions whose risks can be offset and replacing them with a smaller number of contracts while maintaining the same residual exposure.
Operators with portfolios of 500 or more OTC derivatives outstanding with a counterparty must have procedures to regularly (at least twice a year) analyse the possibility of conducting portfolio compression exercises to reduce counterparty risk and to actually carry out such exercises.

Exchange of collateral for non-centrally cleared derivative contracts (likely to enter in force as from September 2016)

Following to the work of the Working Group on Margin Requirements (WGMR), an international working group (with representatives from the Basel Committee, the CPSS (Committee on Payment and Settlement Systems), IOSCO (International Organization of Securities Commissions) and the CGFS (Committee on the Global Financial System)), the European Supervisory Authorities (EBA, ESMA and EIOPA) launched two successive consultations on April 2014 and June 2015 on draft Regulatory Technical Standards (RTS) on risk-mitigation techniques for OTC derivative contracts not cleared by a CCP.

The latest draft RTS prescribe the regulatory amount of initial and variation margin that counterparties should exchange as well as the methodologies for their calculations. In addition, they outline the criteria for the eligible collateral and establish the criteria to ensure that such collateral is sufficiently diversified and not subject to wrong-way risk.

Furthermore, following the amendments of the standards issued by the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) in March 2015, these RTS include a revised phase-in for initial margin requirements and a new phase-in for variation margin. In order to allow a proportionate implementation, the RTS propose that the requirements will enter into force from 1st September 2016, giving counterparties subject to these requirements time to prepare for the implementation. The initial margin requirements would be phased-in over a period of four years and would only apply initially to the largest market participants. Similarly, but with a shorter timescale, the requirements for the implementation of variation margin would be binding for the major market participants from September 2016 and for all the other counterparties falling in the scope of these RTS by 1 March 2017.

Exemption from collateral requirements are provided for intragroup transactions (see “Notifications and calendar” page).

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