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EMIR - What should Hedge Funds be doing?
November 2013
www.pwc.co.uk
November 2013
PwC
2008: OTC market collapse Weaknesses revealed in crisis
2
November 2013
All standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties. OTC derivative contracts should be reported to trade repositories. Non centrally cleared contracts should be subject to higher capital requirements.” - G20 Pittsburgh summit
Collapse of Bear Stearns and Lehmans
AIG’s collapse
G20 commitment
20
08
cr
ed
it c
ris
is
Se
pt’
20
09
• Heightened levels of counterparty credit risk resulting in the decline of lending and market liquidity
• AIG’s collapse showed a lack of transparency in OTC derivatives positions and exposures
G20 agrees the derivatives reform pillars: • Reducing counterparty risk, esp. by stipulating clearing requirements • Reducing operational risk (incl. standardisation & electronic
processing); • Increasing transparency (Reporting obligations and trade
repositories (TRs)); • Improving market integrity.
European Markets Infrastructure Regulations (EMIR)
PwC
*Directive 2004/39/EC of the European Parliament and the Council of 21 April 2004 on markets in financial instruments amending Council Directives 85/611/EEC and 93/6/EEC and Directive 2000/12/EC of the European Parliament and of the Council and repealing Council Directive 93/22/EEC
Products in scope for EMIR Derivatives, derivatives, derivatives EMIR derivative financial instruments defined under the Markets in Financial Instruments Directive (MiFID)*.
Slide 3
General scope of EMIR
Derivatives based on:
• Equities
• Currencies
• Interest rates and yields
• Commodities
• Credit instruments
Products out of scope of EMIR
• Physically settled spot FX
• Physically settled commodities
• Cash equities
• Bonds
• Repos
• Stock borrowing/lending
FX forwards pose particular challenges: exempt from EMIR in the UK and certain other EU member states when used for “commercial purposes”
November 2013
PwC
EMIR – The Key Requirements
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November 2013
EMIR introduces three sets of core obligations for derivative counterparties, aimed at increasing transparency and decreasing counterparty credit risk.
All classes of OTC derivatives declared subject to the EMIR clearing obligation will have to be cleared through an EMIR authorised CCP
Clearing obligations
All derivatives, not only OTC derivatives, must be reported to an ESMA authorised trade repository
Reporting obligations
All OTC derivatives contracts that are not cleared by a CCP will be subject to strict risk mitigation requirements
Risk mitigation
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2
3
To facilitate compliance with these obligations, CCPs must be available to clear trades and TRs to receive reporting. Both entities must be regulated to a robust and consistent standard.
CCP/TR regimes
PwC
EMIR – the obligations and compliance dates
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November 2013
EMIR Obligation Compliance Date Obligation Overview
Risk mitigation requirements for all non-cleared over-the-counter (OTC) derivative contracts
Timely
Confirmations March 15, 2013
• Contracts shall be confirmed within defined timeframes. Timing is phased, and applies to FCs and all NFCs.
• FCs shall have necessary procedures to report on a monthly basis the number of unconfirmed OTC derivative transactions that have been outstanding for more than five business days.
Daily Valuations March 15, 2013 • FCs and NFC+s shall mark-to-market the value of non-cleared outstanding contracts.
• Where market conditions prevent marking-to-market, marking-to-model shall be used.
Portfolio
Compression September 15, 2013
• FCs and NFCs (+500 contracts outstanding uncleared) shall have procedures to regularly analyse the possibility of conducting portfolio compression, with validation/reasoning provided where deemed not appropriate.
Portfolio
Reconciliation September 15, 2013
• FC and NFCs shall agree upon arrangements for the reconciliation of portfolios (frequency of this is based on trade volume/counterparty type).
Dispute Resolution September 15, 2013
• FCs and NFCs shall have detailed procedures and processes related to identification, recording and monitoring of disputes.
• Reporting of disputes to authorities for some long-standing disputes.
Margin and
Collateral Q1 2015
• FCs must maintain procedures for segregated exchange of collateral.
• FCs shall hold proportionate amount of capital to manage the risk not covered by appropriate exchange of collateral.
Reporting obligation for ALL derivative contracts (OTC and exchange-traded)
Transaction
reporting
All asset classes:
February 12 , 2014
• All counterparties must report trade details for cleared and non-cleared trades (with requirements phased in by asset class type, and historical trade reporting from August 16, 2012).
• Counterparties shall keep records of derivative contracts that have concluded, and any modifications, for at least 5 years following the termination of the contract.
Clearing obligations for eligible OTC derivatives contracts
Clearing Q2-3 2014 (est.) • Financial Counterparties and Non-Financial Counterparties above the clearing threshold are required to clear eligible
transactions.
1
2
3
PwC
Key issues for hedge funds
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November 2013
Selecting a clearing broker
• The clearing brokers are expecting to be ‘selective’ about which clients they provide services too
• Bottlenecks and onboarding capacity issues expected
Liability for outsourced obligations
• No ability to delegate liability to execution, clearing and reporting agents
• Firms must be able to demonstrate adequate due diligence and supervision of agents
Higher margin unavoidable
• EU legislators likely to set uncleared margin and collateral levels as high, if not higher, than cleared margin levels to encourage clearing
• Sell side firms looking to cash in on collateral optimisation – Shop around for the best deal
Extra-territoriality: The wild card
• EMIR contains a broad clause that captures transactions in which no EU counterparty is involved
• ESMA published rules in Q4 2013
PwC
What should you being doing now?
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November 2013
1. Classify Counterparties –
• Your funds and your counterparties
• Register NFC+ status with FCA
2. Review and comply with obligations already in force
• Confirm compliance or mobilise project
• Upgrade confirmation processes
• Upgrade collateral processes
3. Prepare for transaction reporting
• Review data elements and plug gaps
• Determine whether to report via Trade Repository or delegated reporting route
4. Get ready for clearing
• Review clearing broker requirements and issue RFP
5. Review legal documentation
• Legal docs will need updating for new obligations and for clearing
Checklist
PwC
Contacts
8
November 2013
Crispian Lord
Partner
Tel: +44 (0) 20 7804 8148
Mobile: +44 (0) 7977 198677
Email: [email protected]
Betsy Dorudi
Senior Manager
Tel: +44 (0) 20 7213 5270
Email: [email protected]
James Chrispin
Director
Tel: +44 (0) 20 7804 2327
Mobile: +44 (0) 7711 109942
Email: [email protected]
Che Sidanius
Director
Tel: +44 (0) 20 7804 8762
Mobile: +44 (0) 7808 035854
Email: [email protected]
Neha Chandgothia
Manager
Tel: +44 (0) 20 7804 0390
Mobile: +44 (0) 7942 756863
Email: [email protected]
PwC
Appendix
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November 2013
PwC
Counterparty definition under EMIR EMIR distinguishes two types of counterparties: Financial Counterparties (FCs) and Non-financial Counterparties (NFCs)
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November 2013
Financial Counterparties
(FC)
• Any entity authorised in accordance with EU law as an investment firm, credit institution, insurance undertaking, assurance undertaking, reinsurance undertaking, UCITS and its management company, institution for occupational retirement provision and an alternative investment fund managed by AIFMs authorised or registered in accordance with AIFMD.
• FCs are subject to the most stringent EMIR obligations.
Non-Financial Counterparties
(NFC+)
• Any other entity that is established in the EU which is not an FC or a CCP; and whose positions in OTC derivatives (excluding hedging positions) exceed a specified clearing threshold (gross notional value), assessed on a 30 day rolling average and in that period remains above this threshold:
1. Credit = €1bn 2. Equity = €1bn 3. Interest rate = €3bn 4. Foreign exchange = €3bn 5. Commodities = €3bn
• NFC+s are subject to obligations similar to those for FCs.
• Any other entity that is established in the EU which is not an FC or a CCP; and whose derivative trading activities are under the clearing threshold.
• NFC-s are not subject to mandatory clearing, daily valuation, and non-centrally cleared margin requirements.
Non-financial Counterparties
(NFC-)
PwC
Application of EMIR rules The application of the three core EMIR obligations varies for each counterparty type (FC, NFC+, NFC)
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November 2013
Clearing obligation?*
Reporting obligation?
Risk mitigation measures?
Risk mitigation margin
requirements?
Risk mitigation capital
requirements?
Financial counterparties (FCs)
Yes Yes Yes Yes Yes
Non-financial counterparties (NFC+)
Yes Yes Yes** Yes No
Non-Financial Counterparties (NFC-)
No Yes Yes** No No
Notes
• Under EMIR, the clearing obligation applies to transactions between financial counterparties, non-financial counterparties whose positions (excluding certain hedges) exceed a specified clearing threshold and non-EU entities which will be captured by EMIR extra-territorial rules.
• EMIR requires financial counterparties to hold appropriate capital for uncollateralised risk, the level of capital is yet to be defined. However, capital requirements will be dealt with under Basel III and Solvency II. Some large corporations that are not financial counterparties may also have to comply depending on the size of their Treasury functions.
• The Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) in their second consultative document on margin requirements for non-centrally cleared derivatives (15 March 2013) state that margin requirement only apply to financial firms and systemically important non-financial entities.
•The clearing obligation will only apply to classes of OTC derivatives which are mandated by EU law to be cleared. **Only FCs are required to report any unconfirmed trades that are outstanding for more than 5 business days and report disputes between counterparties relating to OTC derivative contracts. NFC-s not required to undertake daily valuations.
PwC
Key compliance dates The EMIR level 1 text came into force on August 2012, however most of the key obligations are set to come into force over a staggered timeframe from March 2013.
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November 2013
16 August 2012 • EMIR came
into force • Historic transaction
reporting period commenced
15 March 2013
• Technical Standards for CCPs, TRs and most obligations for firms in force (phased in)
• Mark to market valuation for uncleared trades (FC, NFC+)
• First timely confirmation deadlines introduced
1 September 2013 • Second timely
confirmation deadlines introduced
15 September 2013
• Dispute resolution, portfolio compression and reconciliation for non-centrally cleared derivatives in effect
Q4 2013 (est) • CCPs authorised • Disclosure and
segregation requirements for clearing members
12 February 2014
• Commencement of reporting obligation. Reporting for collateral follows 180 calendar days later.
1 March 2014 • Third timely
confirmation deadlines introduced
Q2-3 2014 (est.) • Third country rules
take effect
Q2-3 2014 (est.) • First set of clearing
obligations commence
1 September 2014 • Fourth timely
confirmation deadlines introduced
1 December 2015 (est.) • Margin for non-centrally
cleared trades in effect. Phase-in period for implementation
Key:
Risk mitigation
Reporting
Clearing
Third country rules
Some implementation dates set by counterparty classification, type of product and frequency of trading
PwC
PwC EMIR accelerators and tools
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November 2013
EMIR tools/materials
Introductory and targeted EMIR training
EMIR FAQs
Key legislation
Implementation guidance
Sample policies and procedures
Governance and rules identification and analysis
PwC
PwC points of view
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November 2013
We have produced a series of thought leadership pieces, examples of which are:
• All clear? – Our thoughts on how to ensure you are operationally ready to meet the new clearing, reporting and collateral requirements.
• Securing your access – Securing access to clearing services is more than just a procurement exercise. Our expertise and insight can help you achieve the right result.
• Voice of the customer – Changing demand requires solutions along the value chain. Forward-looking banks are listening to what clients really want and responding accordingly.
This publication has been prepared for general guidance on matters of interest only, and does
not constitute professional advice. You should not act upon the information contained in this
publication without obtaining specific professional advice. No representation or warranty
(express or implied) is given as to the accuracy or completeness of the information contained
in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its
members, employees and agents do not accept or assume any liability, responsibility or duty of
care for any consequences of you or anyone else acting, or refraining to act, in reliance on the
information contained in this publication or for any decision based on it.
© 2013 PricewaterhouseCoopers LLP. All rights reserved. In this document, “PwC” refers to
PricewaterhouseCoopers LLP (a limited liability partnership in the United Kingdom) which is a
member firm of PricewaterhouseCoopers International Limited, each member firm of which is a
separate legal entity.