Sea of Change Regulatory reforms – charting a new course

Territorial Scope of Reporting, Clearing and Trading Chris Bates

May 2014

Clifford Chance

Sea of Change Regulatory reforms - charting a new course

EMIR and MiFID2/MiFIR: timeline

• Estimated start dates for these obligations.

2 Territorial scope

MiFID2/MiFIR: transparency, platform trading, position limits, etc.*

18 March 2014

First CCP authorised:

Clearing member obligations

Frontloading

Margining uncleared trades*

15 September 2013

Portfolio reconciliation Portfolio compression

Dispute resolution

15 March 2013

Confirmations Daily valuation NFC+ reporting

Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q1

2013 2014 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q1

2015 2016 2017

First clearing obligation

starts*

3 year phase-in for NFC+s

10 April/10 October 2014 Application to TCE-TCE trades

1 January 2014 CRD4/CRR: capital rules

12 February/11 August 2014 Reporting to TRs

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Sea of Change Regulatory reforms - charting a new course

Obligation to clear transactions through a CCP authorised or recognised in the EU

Obligation for non-financial counterparties subject to clearing to notify regulator Clearing

What obligations are imposed under EMIR?

Operational risk mitigation: arrangements for timely confirmation, portfolio reconciliation and compression and dispute resolution (and reporting to regulators)

Daily valuation: mark-to-market and mark-to-model Margining: mandatory exchange of margin Capital for uncollateralised risk

Reporting of transactions to trade repositories (TRs) registered or recognised by ESMA

Record keeping of transactions

Disclosure of fees and client protections, segregation of accounts and use of margin

Risk mitigation

Reporting to TRs

Members of CCPs

3 Territorial scope

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Sea of Change Regulatory reforms - charting a new course

Who is subject to the EMIR obligations?

4 Territorial scope

Financial counterparty (FC) Investment firms Credit institutions Insurance/reinsurance companies Pension funds UCITS (mutual funds) and their managers Alternative investment funds (AIF) managed by AIF

manager If authorised or registered under relevant EU directive

Non-financial counterparty (NFC) Undertaking … …established in the EU … …not an FC or CCP

Non-EU entity (TCE) Undertaking established outside the EU Which would be subject to the relevant obligation if

established in the EU

Exempt entities:

Non-financial counterparty over the clearing threshold (NFC+) NFC... …whose positions in OTC derivatives… …exceed the clearing threshold Obligation to notify competent authority (effective 15

March 2013)

Article 1(4) Article 1(5) Pension funds (clearing)

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Sea of Change Regulatory reforms - charting a new course

Who is subject to the EMIR obligations?*

5 Territorial scope

Clearing FCs** NFC+s** TCEs***

Risk mitigation:

Operational: procedures FCs NFC+s Other NFCs

Operational: reporting to regulators FCs

Daily valuation FCs NFC+s

Margining **** FCs NFC+s

Capital FCs

Reporting to TRs FCs NFC+s Other NFCs

Members of CCPs Members of EU authorised CCPs

• Does not address trades between two TCEs; ** if counterparty is an FC, NFC+ or TCE; *** if counterparty is an FC or NFC+; **** if counterparty is an FC, NFC+ or any non-EU entity (proposed)

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Sea of Change Regulatory reforms - charting a new course

Where do the clearing and risk mitigation rules apply?

* Clearing rules only apply to NFC+s; ** ESAs propose that FCs and NFC+s should collect margin from all non-EU entities

6 Territorial scope

EU Non-EU

FC or NFC*

FC or NFC*

FC or NFC* TCE**

TCE TCE

OTC derivative

OTC derivative

OTC derivative

Note: Categorisation of a branch likely to follow categorisation of legal entity. Non-EU AIFs are categorised as FCs in the EU if they are managed by an AIF manager authorised or registered in EU under AIFM Directive.

Only if transaction has a direct, substantial and

foreseeable effect in the EU or if necessary or

appropriate to prevent evasion of EMIR rules Exceptions:

•NFC+ notification; •Daily valuation; •FC regulatory reporting obligations

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Sea of Change Regulatory reforms - charting a new course

The clearing and risk mitigation obligations apply to transactions between TCEs where: •The transaction would have a “direct, substantial and foreseeable effect” within the EU; or

•It is necessary or appropriate to apply the obligation in order to prevent evasion.

Technical standards adopted by the European Commission define when these provisions apply.

Application to transactions between two TCEs

7 Territorial scope

“Direct, substantial and foreseeable effect”: • Where one counterparty benefits from a guarantee (meeting

specified quantitative standards) from an FC; or • Where two EU branches or non-EU entities deal with each

other • Applies from 10 October 2014

“Necessary or appropriate to prevent evasion”: • Where primary purpose to defeat object, spirit or purpose of EMIR • Including where part of an artificial arrangement • Arrangement is artificial if lacks business rationale, commercial substance or relevant economic justification • Applies from 10 April 2014

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Sea of Change Regulatory reforms - charting a new course

Application to asset management clients

EU established funds and clients

If they are FCs or NFCs (and not exempt)

Required to comply with EMIR clearing, reporting and risk mitigation rules (as applicable)

Even if the asset manager/counterparty outside EU

Practical issues around delegation of performance

Non-EU established funds and clients

Not required to comply with EMIR clearing, reporting and risk mitigation rules

Even if asset manager/counterparty in EU

Except:

• Non-EU AIFs managed by an EU authorised/registered AIFM are treated as FCs (i.e. EU)

• Clearing obligation may apply if transact with an FC/NFC+

• If transact with an FC/NFC may be required to facilitate their compliance

• Possible application of TCE-TCE rules

8 Territorial scope

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Sea of Change Regulatory reforms - charting a new course

EMIR envisages equivalence assessments by the Commission of non-EU jurisdictions: as part of the recognition process for non-EU CCPs;

as part of the recognition process for non-EU TRs;

for the purpose of determining the exemption from conflicting or duplicative clearing, reporting and risk mitigation obligations for transactions with a counterparty established in an equivalent non-EU jurisdiction (also relevant to the intra-group exemption).

Deemed compliance Where at least one counterparty is established in an equivalent jurisdiction, both counterparties are deemed to have complied with the clearing, risk mitigation and reporting obligations.

No clear timetable for the Commission to adopt its assessments after receives advice Positive assessment depends on progress in non-EU jurisdictions

in adopting and implementing regulations reflecting G20 commitments.

Timing may be affected by negotiations on US extraterritoriality.

Duplicative or conflicting obligations?

9 Territorial scope

CCPs TRs Conflicting/ duplicative rules

US

Japan

Australia

Hong Kong

Singapore

Switzerland

Canada

India

South Korea

Rest of world

Key – nature of ESMA advice on non-EU regime:

Non-EU regime equivalent (exc. ASX equities clearing)

Non-EU regime only partially/conditionally equivalent (or reciprocity issues)

Premature to give advice

No current request for ESMA advice

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Sea of Change Regulatory reforms - charting a new course

Intra-group transaction exemption

Apply to / notify competent authority

Not less than 30 days in advance

Article 3 EMIR definition of “intragroup”

Additional requirements to be met for margin obligation

Clearing / margin obligations Parties using exemption from the margin

rules for intra-group transactions are subject to ongoing public disclosure requirements. For transactions with non-EU group

companies, it may be necessary for the Commission first to have assessed the non-EU jurisdiction as having “equivalent” regulation for EMIR purposes. UK FCA has made its Web Portal

available for applications for exemption between two UK group entities.

10 Territorial scope

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Sea of Change Regulatory reforms - charting a new course

Must be traded only on:

Declared subject to mandatory venue trading obligation

Regulated market MTF OTF

Equivalent third country

market

OTC derivative subject to the clearing obligation under EMIR

Derivatives – mandatory trading obligation under MiFIR

11 Territorial scope

In order to become subject to mandatory trading, derivatives must be: Admitted to trading on at least one

relevant trading venue;

Sufficiently liquid

ESMA to take into account anticipated impact on liquidity of relevant derivatives and commercial activities of end users

ESMA also to consider whether derivatives only sufficiently liquid in transactions below a certain size

Not an intragroup transaction under Article

3 EMIR

Not subject to transitional provisions under Article 89 EMIR

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Sea of Change Regulatory reforms - charting a new course

Must be traded only on:

Declared subject to mandatory venue trading obligation

Regulated market MTF OTF

Equivalent third country

market

OTC derivative subject to the clearing obligation under EMIR

Derivatives – mandatory trading obligation (2)

12 Territorial scope

Effective equivalent recognition for EU trading venues in relation to derivatives;

Commission decision that there are equivalent legally binding requirements: – Authorisation and supervision; – Venue has clear and transparent

rules on admission to trading; – Issuers are subject to periodic

information requirements; – Market abuse rules

Commission decision only for purposes of determining eligibility as a trading venue for these purposes, and may be limited to a category or categories of trading venues.

Not an intragroup transaction under Article

3 EMIR

Not subject to transitional provisions under Article 89 EMIR

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Sea of Change Regulatory reforms - charting a new course

Who is subject to mandatory trading?

13 Territorial scope

EU Non-EU

FC or NFC+

FC or NFC+

FC or NFC+

Third country financial

institution or

TCE

TCE TCE

OTC derivative

OTC derivative

OTC derivative

Note: Exemption for duplicative or conflicting obligations. Treatment of entities exempt under Article 1(4) or 1(5) EMIR?

Only if transaction has a direct, substantial and foreseeable effect in the EU or if necessary or appropriate to prevent evasion

Where possible and appropriate, ESMA’s technical standards shall be identical to those under EMIR

FC = financial counterparty NFC+ = non-financial counterparty over the EMIR clearing threshold TCE = non-EU entity which would have been subject to the trading obligation if established in the EU Third country financial institution = non-EU entity authorised to carry on any of the activities listed in BCD, MiFID 2, Solvency II, UCITS, IORPs, AIFMD

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Sea of Change Regulatory reforms - charting a new course

Questions?

14 EMIR update

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