|EMIR – intra-group transactions exemption|
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The process for collecting submissions for intragroup exemption from margin requirements under the EMIR Regulation has started recently.
It may be useful in this context to summarise some main points with respect to exemptions available for intragroup transactions under EMIR.
The preliminary observation is that it would be practicable to consider the creation of a single centre of EMIR competence within a group.
Such an exclusive point of contact (usually the group treasury) could be responsible, in particular, for reporting against the clearing threshold (which takes the global group derivatives position into account), but such a strategy have its merits also when fulfiling other EMIR requirements.
Notably, for EMIR compliance purposes, a uniform, group-wide policy is necessary for defining hedging transactions and for the carefull monitoring of the level of non-hedging activity if trading is outside of this scope.
It is recognised that intragroup transactions may be necessary for aggregating risks within a group structure and that intragroup risks are therefore specific.
There are two intragroup-transactions exemptions under the EMIR legal framework available: one relating to the clearing obligation, and the second regarding collateralisation requirement.
- daily valuation;
are still relevant for intragroup transactions.
Moreover, intragroup transactions must also be included into calculations for the purposes of establishing whether a non-financial counterparty exceeds the clearing threshold (with the exception of risk-reducing transactions).
Firstly, it is, however, necessary to establish which contracts constitute intra-group transactions within the EMIR framework.
Definition of the "intra-group" transaction
OTC derivative contracts may be recognised within non-financial or financial groups, as well as within groups composed of both financial and non-financial undertakings, and if such a contract is considered an intragroup transaction in respect of one counterparty, then it should also be considered an intragroup transaction in respect of the other counterparty to that contract.
Simply put, and subject to some exceptions, an intra-group transaction is a transaction between two undertakings which are included in the same consolidation on a full basis and are subject to appropriate centralised risk evaluation, measurement and control procedures (both conditions must be fulfilled cumulatively).
With respect to credit institutions other preconditions are additionally present, in particular the counterparties being part of the same institutional protection scheme or being credit institutions affiliated to the same central body.
The detailed definition of intra-group transactions is contained in Article 3 of EMIR - being overly complicated provision, nevertheless not free from fatal flaws and contradictions (see for example point 5 of the EMIR Review Report no. 4 of 13 August 2015 - ESMA input as part of the Commission consultation on the EMIR Review (2015/1254).
When it comes to legal definitions of the "group", "subsidiary" and "parent undertaking" EMIR (Article 2(16), (22) and (22)) refers to Articles 1 and 2 of the Seventh Council Directive of 13 June 1983 based on the Article 54 (3) (g) of the Treaty on consolidated accounts (83/349/EEC) (OJ L 193, 18.7.1983, p. 1 as amended), which require the relevant update to Articles 2(11), 4(1)(32) and (33) of the Directive 2013/34/EU on the annual financial statements, consolidated financial statements and related reports of certain types of undertakings (Accounting Directive), on occasion of approaching EMIR revamp.
This technique would improve consistency between EMIR and MiFID II on the respective definitions.
Clearing obligation exemption
Pursuant to the recitals in the preamble to EMIR, since the submission of intra-group transactions to the clearing obligation may limit the efficiency of intragroup risk-management processes, an exemption of intra-group transactions from the clearing obligation may be beneficial, provided this exemption does not increase systemic risk.
Consequently, derivative contracts that are intra-group transactions within the above-defined meaning can be freed from the clearing obligation (Article 4(2) of EMIR).
It is noteworthy that the application of the exemption is dependent on the adequate notification be submitted to the competent authority on time.
Exemption from the clearing requirement only applies where two counterparties established in the Union belonging to the same group have first notified their respective competent authorities in writing that they intend to make use of the exemption for the OTC derivative contracts concluded between themselves. The notification must not be made less than 30 calendar days before the use of the exemption.
In the Q&A document on EMIR ESMA has indicated the 30 calendar day period starts on the calendar day following receipt of the notification by the relevant national competent authorities.
Within the said 30 calendar days after that notification has been received, the competent authorities may object to the use of this exemption if the transactions between the counterparties do not meet the respective conditions (laid down in Article 3 of EMIR), without prejudice to the right of the competent authorities to object after this period of 30 calendar days has expired, if those conditions are no longer met. If there is disagreement between the competent authorities, ESMA may assist those authorities in reaching a consensus.
This exemption only applies to OTC derivative contracts between two counterparties belonging to the same group which are established in the EU Member State and in a third country, where the counterparty established in the Union has been authorised to apply this exemption by its competent authority within 30 calendar days after it has been notified by this counterparty, provided that the conditions laid down in Article 3 of EMIR are met. The competent authority must notify ESMA of that decision.
In the Q&As on EMIR ESMA has, moreover, indicated that if a counterparty is established in a third country, the European Commission must have adopted an implementing act under Article 13(2) in respect of the relevant third country in order for transactions between this counterparty and the counterparty established in the Union within the same group to qualify as intragroup transaction transactions under Article 3.
Another ambiguity was the situation when counterparties established in two different European Union Member States applied for an intragroup transactions exemption from the clearing obligation to their national competent authorities (NCAs) under Article 4(2)(a) of EMIR and the NCAs disagreed on whether the conditions laid down in Article 3 were met. The issue was whether the counterparties could rely on the exemption.
The ESMA's answer was in the negative. Where either counterparty is notified during the 30 calendar day period following application that one NCA objects to the exemption, firms should not rely on the exemption, whether during or after the 30 calendar day period. For the avoidance of doubt, if counterparties apply to their respective NCAs on different dates, they should wait until the end of the later of the two 30 calendar day periods before relying on the exemption (provided neither NCA objected). Counterparties may reapply for the intragroup exemption from the clearing obligation once they have addressed the objection(s) raised by the objecting NCA(s).
The submission's form
There are two different processes for counterparties to benefit from the intragroup exemption from the clearing obligation, depending on whether the counterparty to the intragroup transactions is established in the European Union (non-objection process described under Article 4(2)(a)) of EMIR or in a third country in respect of which the European Commission has adopted an implementing act under Article 13(2) (authorisation process described under EMIR Article 4(2)(b)).
It is to be stressed that counterparties' applications/notifications related to intragroup transactions exemption should be submitted to the respective competent authorities, and not to ESMA.
When a notification under Article 4(2)(a) of EMIR relates to intragroup transactions between counterparties established in different EU Member States, it is expected that similar information is sent to the respective competent authorities.
The issue that may rise some doubts is whether the separate notifications are required from entities forming parts of the group or a uniform submission in the name of the entire group may be made, for instance, by its head office.
It is important to note in that regard, the notification is performed per counterparty to the relevant competent authoritity and may cover all the intragroup OTC derivative contracts fulfilling the conditions, provided the relevant information is clearly provided per counterparty.
Although the counterparty is responsible for the notification to the competent authority, it may delegate the performance of the notification to another entity such as its head office. It is not possible, however, to allow one notification across a group, as the group is made up of different legal entities which may be located in different jurisdictions and may be subject to a different framework.
The process of one notification across a group would not allow for the competent authority assessment (see ESMA's Final Report of 27 September 2012, ESMA/2012/600).
The submission's content and the scope for the competent authority discretion
One may ask what is the scope for the competent authority examination when considering whether to object to/authorise intra-group notifications/applications for clearing exemption.
The express wording of the provisions at issue indicates that authorities should assess only whether the clear-cut intra-group transactions' preconditions (as stipulated in the aforementioned EMIR provisions) are fulfilled.
This indicates, the exercise of the discretion within the process on the part of the competent financial authority is rather limited, and when the notification/application:
- covers parent and subsidiary undertakings within the meaning of Articles 1 and 2 of Council Directive 83/349/EEC (referred to above), and
- undertakings within the group are subject to an appropriate centralised risk evaluation, measurement and control procedures, and
- with respect to counterparties established in a third country (outside the European Union) the European Commission has adopted an implementing act in respect of that third country;
there are no formal obstacles to making use of the clearing exemption.
However, it needs to be recalled, in accordance with Article 3 of EMIR, it is required the counterparties to an intragroup transaction are "subject to an appropriate centralised risk evaluation, measurement and control procedures", and here is the point for potential misunderstandings between the competent authorities and companies applying for exemption from mandatory clearing.
ESMA has supplemented the above, rather laconic, EMIR provisions in the Q&As. Accordingly, when applying for the intragroup exemption from the clearing obligation, the applicant counterparty should at least:
1. describe the risk management policies and controls and how they are centrally defined and applied;
2. demonstrate that senior management is responsible for risk management and that risk measurement is regularly reviewed;
3. demonstrate that regular and transparent communication mechanisms are established within the organisation, so that the management body, senior management, business lines, the risk management function and other control functions can all share information about risk measurement, analysis and monitoring;
4. demonstrate that internal procedures and information systems are consistent throughout the institution and reliable so that all sources of relevant risks can be identified, measured, and monitored on an aggregated basis and also, to the extent necessary, by entity, business line, and portfolio;
5. demonstrate that key risk information is regularly reported to the central risk management function to enable appropriate centralised evaluation, measurement and control risk across the relevant group entities.
This seems to indicate, counterparties without the sophisticated ERM system are hardly able to obtain from the EU competent authorities the exemption from mandatory clearing.
Another ambiguous issue - when the counterparties can start applying for the intragroup exemption from the clearing obligation - has been clarified by ESMA in a document of 20 March 2013.
ESMA stated in that regard that notifications for the intragroup exemptions from the clearing obligation are not expected to be submitted before the first notification from national competent authority to ESMA of the authorised classes of OTC derivatives is received by ESMA i.e. the date on which the first class of OTC derivatives is notified to ESMA and published in the public register.
ESMA added, however, "national regulatory authorities may facilitate the process of those applications at an early stage where they consider it needed according to the nature and dimension of their markets."
Another aspect when it comes to timings is the determination whether it is fully functional to make a clearing exemption submission when the corporate group at issue is well below the clearing threshold or to start relevant preparations in the face of approaching danger only.
There is no an unequivocal answer to such a question, it depends mainly on the preferable organisational culture and on the risk appetite issues.
For practical and prudential reasons, it seems the trigger initiating the relevant clearing exemption procedures on the corporate side should be placed somewhere between 50 and 90% of the clearing threshold.
But, as was said above, there are neither mandatory provisions nor ESMA regulatory clarifications in that regard.
ESMA has, however, explained another important issue involved with timings regarding clearing exemption.
It has clarified, if a counterparty enters into a contract during the frontloading period and is subsequently granted an exemption from the clearing obligation which covers this contract, it is not required to clear the contract when the clearing obligation takes effect, provided that the intragroup exemption is granted before the clearing obligation takes effect.
Collateralisation requirement exemption
Collateralisation (margin) requirement represents an element of the EMIR legal framework for mandatory risk-mitigation techniques designed for OTC derivative contracts not cleared by a CCP (Article 11 of EMIR).
EMIR imposes the requirement on financial counterparties to have risk-management procedures that require the timely, accurate and appropriately segregated exchange of collateral with respect to OTC derivative contracts that are entered into on or after EMIR entry into force.
The said obligation is analogous with respect to non-financial counterparties above the clearing threshold with this difference however that the requirement relates to OTC derivative contracts that are entered into on or after the clearing threshold is exceeded.
In accordance with Article 11(6) to (10) of the EMIR, intragroup transactions (in the meaning defined above) can be exempted from the requirement to exchange collateral if certain requirements on the risk-management procedures are met and there are no practical or legal impediments on the transferability of own funds and the repayment of liabilities.
Pursuant to Article 11(5) EMIR the collateral requirement does not apply to an intragroup transaction that is entered into by counterparties which are established in the same Member State provided that there is no current or foreseen practical or legal impediment to the prompt transfer of own funds or repayment of liabilities between counterparties.
The wording of the said provision indicates, when counterparties to the intragroup transaction are established within the same jurisdiction (the European Union Member State) and the above precondition of "lacking impediments" is fulfilled, such transaction is exempted from the EMIR collateral requirement without any further notification or authorisation processess.
The intragroup collateral exemption has in this case an "automatic" character.
In other instances there is either an approval or a notification process, depending on the type of counterparties and the place of establishment (see details in the attached FCA's video).
The scope for and the meaning of the phrase 'practical or legal impediment' have been made more comprehensible by the Consultation Paper of 14 April 2014 "Draft regulatory technical standards on risk-mitigation techniques for OTC-derivative contracts not cleared by a CCP under Article 11(15) of Regulation (EU) No 648/2012" (JC/CP/2014/03), which presented the preliminary thinking of European financial supervisory authorities.
The said issue has been subsequently stipulated in Articles 33 and 34 of the Commission Delegated Regulation (EU) 2016/2251 of 4 October 2016 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council on OTC derivatives, central counterparties and trade repositories with regard to regulatory technical standards for risk-mitigation techniques for OTC derivative contracts not cleared by a central counterparty - see box.
Furthermore, specific requirements apply as regards intragroup transaction that is entered into by counterparties which are established in different Member States as well as intragroup transaction that is entered into by a counterparty which is established in the Union and a counterparty which is established in a third-country jurisdiction. These are specified in Article 11 (6) – (10) of EMIR and seem to be overly casuistic.
Overall, the additional precondition for the risk-management procedures that are "adequately sound, robust and consistent with the level of complexity of the derivative transaction" is required in this case.
According to Recital 38 of the Commission Delegated Regulation 2016/2251 for a group to be deemed to have adequately sound and robust risk management procedures, a number of conditions have to be met.
The group should ensure a regular monitoring of the intragroup exposures, and the timely settlement of the obligations resulting from the intragroup OTC derivative contracts should be guaranteed based on the monitoring and liquidity tools at group level that are consistent with the complexity of the intragroup transactions.
Public disclosures of notional amounts covered by the collateral exemption
It should be noted that EMIR imposes a requirement on the counterparty of an intragroup transaction which has been exempted from the collateralisation obligation to publicly disclose information on the exemption.
This is stipulated in Article 11(11) EMIR.
Pursuant to the Commission Delegated Regulation (EU) No 149/2013 of 19 December 2012 supplementing Regulation (EU) No 648/2012 of the European Parliament and of the Council with regard to regulatory technical standards on indirect clearing arrangements, the clearing obligation, the public register, access to a trading venue, non-financial counterparties, and risk mitigation techniques for OTC derivatives contracts not cleared by a CCP (RTS), the information on an intragroup exemption to be disclosed publicly includes:
(b) the relationship between the counterparties;
(c) whether the exemption is a full exemption or a partial exemption;
(d) the notional aggregate amount of the OTC derivative contracts for which the intragroup exemption applies.
The purpose of the public dislosure is to ensure transparency in respect of market participants and potential creditors.
As the Recital 37 of the said Regulation 149/2013 underlines, this is particularly important for the potential creditors of the counterparties in terms of assessing risks.
The disclosure aims at preventing misperception that OTC derivative contracts are centrally cleared or subject to risk mitigation techniques when it is not the case.
It is noteworthy, the requiremt for public disclosure at issue applies equally to instances where the collateral intragroup exemption is subject to the application/notification requirements as well as where it has an "automatic" character (i.e. in the circumstances of Article 11(5) EMIR).
The application/notification content and timing
As was said above, the application/notification requirements are not used with respect to counterparties to the intragroup transaction established in the same EU Member State.
When it comes to other instances, pursuant to the RTS, the application or notification to the competent authority of the details of the intragroup transaction for the purposes of the collateral exemption should include:
(b) the corporate relationship between the counterparties;
(c) details of the supporting contractual relationships between the parties;
(d) the category of intragroup transaction as specified under paragraph 1 and points (a) to (d) of paragraph 2 of Article 3 of EMIR;
(e) details of the transactions for which the counterparty is seeking the exemption, including:
(i) the asset class of OTC derivative contracts (i.e. credit, equity, interest rate, foreign exchange, commodities, other);
(ii) the type of OTC derivative contracts;
(iii) the type of underlyings;
(iv) the notional and settlement currencies;
(v) the range of contract tenors;
(vi) the settlement type;
(vii) the anticipated size, volumes and frequency of OTC derivative contracts per annum.
Recital 36 of the RTS explains that the anticipated size, volumes and frequency of intragroup OTC derivative contracts may be determined on the basis of the historical intragroup transactions of the counterparties as well as the anticipated model and activity expected for the future.
Furthermore, as part of the application or notification to the relevant competent authority, a counterparty is obliged to submit supporting information evidencing that the conditions for intragroup exemption set by EMIR are fulfilled.
The supporting documents include copies of documented risk management procedures, historical transaction information, copies of the relevant contracts between the parties and may include a legal opinion upon request from the competent authority.
Recital 37 of the Commission Delegated Regulation 2016/2251 underlines that when a counterparty notifies the relevant competent authority regarding its intention to take advantage of the exemption of intragroup transactions, in order for the competent authority to decide whether the conditions for the exemption are met, the counterparty should provide a complete file including all relevant information necessary for the competent authority to complete its assessment.
The aforementioned Consultation Paper of 14 April 2014 Draft regulatory technical standards on risk-mitigation techniques for OTC-derivative contracts not cleared by a CCP under Article 11(15) of Regulation (EU) No 648/2012 (JC/CP/2014/03) contains additional comments on the procedure before the competent authority.
Firstly, the application will be deemed to have been received when it will be deemed complete by the competent authority. This includes a possibility for the competent authority to ask for more information.
EMIR stipulates in Articles 11(6) - 11(10) that counterparties must submit applications or notifications to their respective competent authorities.
Depending on the nature of the counterparties (financial counterparties, non-financial counterparties or third-country entities), the exemption will be subject to either a decision or a potential objection from the competent authorities.
Instead of refusing or objecting to an exemption on the grounds that the competent authority does not have the necessary information to verify that the relevant conditions have been fulfilled, the competent authority will have the option to go back to the applicant and in this respect provide more time and explanations, which should be to the benefit of the counterparties seeking the exemption.
Another advantage is that the timeline within which the competent authorities are required to notify the counterparties of the outcome of the request for exemption will only start once the applications or notifications are deemed to be complete.
Several requests for information may be sent, providing both the competent authorities and the counterparties with opportunities to reassess the files and complete the applications.
This flexibility has, however, also shortcomings, the main disadvantage is the timing issue and the legal certainty.
When counterparties apply for the exemption, they won't be able to determine the time required to obtain the exemption until their application is deemed complete.
This may be particularly problematic under Articles 11(6), 11(8) and 11(10) where counterparties can only start using the exemptions after the decision has been taken by the competent authorities.
The risk is that this phase of the application has no time-limit.
The said drawback does not apply to an "automatic" exemption under Article 11(5) EMIR.
Also the non-financial counterparties may benefit from the exemption from collateral requirements as of the date of notification of their exemption to their competent authority.
This exemption remains valid unless the competent authority considers that the conditions to benefit from this exemption are not met, within a period of three months after the notification.
|Last Updated on Wednesday, 22 February 2017 20:44|