Implications for financial companies

The central clearing obligation imposed by EMIR relates to standardised OTC derivative contracts. Derivative contracts that cannot be cleared centrally may be cleared bilaterally. EMIR has set strict conditions for this bilateral clearing to ensure an equal degree of risk control of these transactions compared to centrally cleared transactions.

EMIR sets several requirements for bilateral clearing, including:

Timely confirmation of new transactions

New OTC derivative transactions that are cleared bilaterally must be confirmed as soon as possible. Whenever possible, this can be done electronically.

Reporting transactions that have not been confirmed in time

If financial counterparties cannot confirm OTC derivative transactions in a timely manner, they must report the transactions on a monthly basis. Such notifications must include transactions outstanding for more than five working days (counting from the time they should have been confirmed). Financial parties with an AFM licence must make the notification to the AFM. Financial parties licensed by DNB must make the notification to DNB. The notification must be made no later than 10 working days after the end of the month in question.

Revaluation of derivative positions at market value

Financial counterparties and non-financial counterparties that exceed the clearing threshold when entering into a derivative transaction are obliged to calculate the value of outstanding derivative contracts at market value (mark-to-market, or where this is not possible, mark-to-model) on a daily basis. When the mark-to-model model is used, for example, because certain market conditions prevent the use of the mark-to-market model, the party must ensure that the model is reliable and sound.

Risk management of bilaterally cleared OTC derivatives

Bilaterally cleared derivative transactions are subject to certain risk management obligations. These obligations relate to portfolio reconciliation, portfolio compression and dispute resolution and will apply to all outstanding OTC derivative contracts that are not centrally cleared.

Reconciling portfolios

Portfolio reconciliation ensures that parties to an OTC derivative contract establish equal transaction terms. The obligation to carry out portfolio reconciliation is laid down in Article 13 of the Commission Delegated Regulation (EU) No 149/2013.

Financial and non-financial counterparties to an OTC derivative contract must agree (in writing), prior to entering into that contract, on the manner in which the transactions will be reconciled. The reconciliation must include the key terms and value of each derivative contract.

Financial counterparties and non-financial counterparties that exceed the clearing thresholds when entering into a derivative transaction must carry out the reconciliation of transactions at the following times:

- every working day, in the event that the counterparties have 500 or more OTC derivative contracts outstanding with each other; or
- once a week, in the event that the counterparties have between 51 and 499 OTC derivative contracts outstanding with each other; or
- once a quarter, in the event that the counterparties have 50 or fewer OTC derivative contracts outstanding with each other.

Non-financial counterparties that fall below the clearing thresholds must perform transaction reconciliation at the following times:

- once a quarter, in the event that the counterparties have more than 100 OTC derivative contracts outstanding with each other at any time during the quarter;
- once a year, in the event that the counterparties have 100 or fewer OTC derivative contracts outstanding with each other.

Compressing portfolios

Portfolio compression means that parties to OTC derivatives maintain the same risk position, but reduce the number of contracts. The obligation to compress portfolios is laid down in Article 14 of Commission Delegated Regulation (EU) No 149/2013 for both financial and non-financial counterparties with 500 or more outstanding OTC derivative contracts that are not centrally cleared with a single counterparty. These parties must have procedures in place to regularly, at least twice a year, analyse whether it is possible to compress portfolios. The counterparties must provide a reasonable and valid explanation to the relevant authority if it is concluded that a portfolio compression exercise is not appropriate.

Dispute resolution

Article 15 of the Commission Delegated Regulation (EU) No 149/2013 requires both financial and non-financial counterparties to have detailed procedures and processes on disputes in place when entering into OTC derivative contracts with each other. These procedures must include the identification, recording and monitoring of disputes related to the recognition or value of the contract and the exchange of collateral between parties. The procedures will at least record the duration of the unresolved dispute, the counterparty and the amount in dispute. Furthermore, there must be a specific process for disputes that are not resolved within five working days.

In addition to the reporting obligation, EMIR also stipulates that certain types of OTC derivative contracts between financial parties must be cleared centrally by a so-called ‘Central Counterparty (CCP)’. EMIR thus aims to ensure the stability of the financial system, the intervention of the CCP should prevent the bankruptcy of one market participant from causing the bankruptcy of other market participants by eliminating the counterparty risk that parties run on each other.

The European Commission (on the advice of the European supervisor ESMA) has designated the OTC derivatives to which the central clearing obligation applies. In general, these are standardised derivatives that can be cleared by a CCP.

For users of derivative contracts, the clearing obligation means that they must have access to a CCP, which is possible through membership with a Clearing Member. Users will be required to maintain collateral for the transactions to be cleared with the Clearing Member to which they are affiliated.

The clearing obligation applies to all financial parties that have entered into a transaction in any derivatives designated by ESMA.

Exception for small financial counterparties

Small financial counterparties may claim an exemption from the clearing obligation as long as they remain below certain clearing thresholds. Once a financial counterparty exceeds the clearing threshold or chooses not to calculate the clearing thresholds, it is subject to the clearing obligation and must report this to its supervisor and to ESMA.

Intra-group exception to central clearing obligation

For derivative contracts entered into within a group, EMIR provides an exemption from the central clearing obligation. In order to use this exemption, the intra-group exception to the central clearing obligation must be invoked.

In the event of derivative transactions between a Dutch counterparty and a counterparty within the EU, it must notify the supervisor in accordance with Article 4(2)(a) of EMIR.
In the event of derivative transactions between a Dutch counterparty and a counterparty outside the EU, it must notify the supervisor in accordance with Article 4(2)(b) of EMIR.

When?

The AFM starts processing notifications and applications for the intra-group exception the moment the first class of OTC derivatives qualifies for mandatory central clearing and the parties under AFM supervision must comply with this obligation.

Intra-group exception to collateral exchange obligation

A counterparty can invoke the intra-group exception to the obligation to exchange bilateral collateral under Article 11(3) of EMIR in several ways:

1. In the event of derivative transactions between a Dutch counterparty and another Dutch counterparty belonging to the same group, no formal notification or application is required. In that case, the counterparties must meet the conditions under Article 11(5) of EMIR.

2. In the event of derivative transactions between a Dutch financial counterparty and a financial counterparty within the EU belonging to the same group, an application for an exemption must be submitted in accordance with Article 11(6) of EMIR.

3. In the event of derivative transactions between a Dutch non-financial counterparty and a non-financial counterparty within the EU belonging to the same group, an application for an exemption must be submitted in accordance with Article 11(7) of EMIR.

4. In the event of derivative transactions between a Dutch non-financial counterparty and a financial counterparty within the EU belonging to the same group, no formal notification or application needs to be made to the supervisor of the non-financial counterparty. In that event, an application for an exemption must be made to the supervisor of the financial counterparty in accordance with Article 11(10) of EMIR. The supervisor of the financial counterparty will then inform the supervisor of the non-financial counterparty of its decision.

5. In the event of derivative transactions between a Dutch counterparty and a counterparty belonging to the same group established in a country outside the EU with which the European Commission has achieved equivalence, an application for an exemption must be made in accordance with Articles 11(8) and 11(9) of EMIR.

6. In the event of derivative transactions between a Dutch counterparty and a counterparty belonging to the same group established in a country outside the EU with which the European Commission has not achieved equivalence, an application for an exemption must be made in accordance with Article 36 of the RTS bilateral clearing requirements.

Please note that where counterparties are established in two different EU Member States and the competent national authorities disagree as to whether the relevant conditions are met, the exemption in principle does not apply. The relevant notification forms can be found on the website.