With several Dodd-Frank Title VII swaps reform implementation deadlines coming to pass over the last several years, US-based asset managers that trade derivatives in Europe have directed their attention towards EMIR (European Markets and Infrastructure Regulation), the EU’s answer to Title VII.
Despite both Dodd-Frank Title VII and EMIR falling under the G20’s September 2009 mandate to enhance the transparency and regulation of OTC swaps, there are still substantial differences between the two, which include the following:
Classification of swaps:
The derivative security types that require reporting under Dodd-Frank do not align exactly with those that require reporting under EMIR. Under Dodd-Frank, for example, the SEC and CFTC have divided swaps into four different categories of “Title VII” swaps: Swaps, Security-Based Swaps, Mixed Swaps, and Security-Based Swaps, while the securities that fall under EMIR are defined by MiFID (the Markets in Financial Instruments Directive).
In the U.S., certain types of derivatives in the Swaps and Security-based swaps categories are excluded from clearing and other requirements, whereas in the EU, only spot foreign exchange contracts, and some physically-settled commodity swaps are excluded.
The types of entities that need to report derivatives transactions are categorized differently under the two different regimes. For example, the Swap Dealer (SD) and Major Swap Participant (MSP) categories in the US are not used under EMIR, rather counterparties are grouped into financial, or non-financial entity buckets. To complicate things, each country within the EU has their own regulator, which oversees reporting and financial counterparty registration in each local market.
From a reporting standpoint, EMIR requires that both counterparties in a deal report to a trade repository (although this can be delegated, even to the other counterparty), whereas Dodd-Frank only requires at most one counterparty to report. In cases where a swap is exchange- traded and centrally cleared, the counterparties are not responsible for clearing. A final difference in reporting requirements between the two regimes is that EMIR transaction reporting will be end-of-day, whereas Dodd-Frank is in most cases real-time.
Central clearing of swaps under EMIR will come into effect in 2014 after a list of contracts requiring clearing is completed by ESMA (the European Securities and Markets Authority) and then passed into law. Entities that trade contracts which do not require clearing will still need to take risk mitigation measures (e.g. collateralization of the transactions) around those contracts.
A word on cross-border transactions
After a period of uncertainty regarding the status of transactions involving one US, and one European, counterparty, on June 25, 2014 the SEC approved its final rules regarding SDs and MSPs involved in cross-border security-based swap activities. These rules, which are meant to align the SEC’s cross-border requirements with those of the CFTC, and provide a framework for substituted compliance, would permit foreign regulatory requirements to stand in for the corresponding SEC rules. After an application and approval process, this would presumably permit US market participants involved with EU derivatives transactions to avoid following SEC requirements assuming that they were in compliance with EMIR.
From an EMIR standpoint, the groundwork has been laid for recognizing foreign regulatory regimes for OTC cross border transactions, however the implementation of the process for doing so has not yet occurred.
To summarize, if US asset managers want to trade derivatives in the US and Europe without interruption, they will need to prepare for transaction reporting, clearing, affirmation, collateralization, etc. in both markets. This will require resources dedicated to keeping track of regulatory developments in both markets, and adjusting project plans and technical requirements accordingly. Finally, firms will also need to keep apprised of regulatory changes impacting swaps in Asian markets as necessary.
Material from the pwc Regulatory Brief “Derivatives-Enter EMIR, You’re going to need a bigger boat” (http://www.pwc.com/en_US/us/financial-services/regulatory-services/publications/assets/pwc-fs-reg-brief-derivatives-emir.pdf), and the Foxeye white paper on “10 myths around EMIR” (found at http://foxeye.net/files/Whitepaper_FOXEYE_10MythsAroundCCP.pdf) was used in preparing this article.
Disclaimer: This article is being provided to IMP clients and prospects for high-level informational purposes only, and should not be interpreted as legal advice.
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This article was authored by Roger Binggeli, Senior Compliance Consultant. For more information, please contact Roger at firstname.lastname@example.org or Jane Stabile at email@example.com. Roger can also be reached on 617-314-7415.