|EMIR – intra-group transactions exemption|
|Monday, 30 July 2012 07:59|
Status of the intra-group transactions under the EMIR legal framework should be considered with respect to clearing obligation and collateralisation requirement separately.
As a follow-up to the short description of the key elements of the new legal framework for EMIR (Regulation of the European Parliament and Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories (OJ L 201, 27.7.2012, p. 1) - European Market Infrastructures Regulation)it’s time to make a cursory overview of the new provisions that enable undertakings to make use of the intra-group transactions exemption.
Definition of the intra-group transaction
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 (see full consolidation criteria according to EMIR) and are subject to appropriate centralised risk evaluation, measurement and control procedures (both conditions must be fulfilled jointly).
With respect to entities covered by the Directive 2006/48/EC (i.e. banks) another premise is applied, i.e. the counterparties must part of the same institutional protection scheme referred to in Article 80(8) of Directive 2006/48/EC or they are credit institutions affiliated to the same central body or such credit institution and the central body, as referred to in Article 3(1) of that Directive.
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. It is recognised that intragroup transactions may be necessary for aggregating risks within a group structure and that intragroup risks are therefore specific.
The detailed definition of intra-group transactions in contained in Article 3 of EMIR.
Status of the intra-group transactions under the EMIR legal framework for systemic purposes should be considered with respect to clearing obligation and collateralisation requirement separately.
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 that this exemption does not increase systemic risk.
Thus, derivative contracts that are intra-group transactions within the above-defined meaning are not subject to the clearing obligation (Article 4(2) of EMIR). This is, however, without prejudice to the requirement for risk-mitigation techniques envisioned in EMIR (see further).
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 be made not less than 30 calendar days before the use of the exemption.
Within 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 conditions laid down in Article 3, 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 an agreement.
This exemption only applies to OTC derivative contracts between two counterparties belonging to the same group which are established in a 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 the counterparty established in the Union, provided that the conditions laid down in Article 3 are met. The competent authority must notify ESMA of that decision.
Collateralisation requirement exemption
Collateralisation requirement must be analysed irrespective of the clearing obligation.
The legal framework for mandatory risk-mitigation techniques for OTC derivative contracts not cleared by a CCP is contained in Article 11 of EMIR.
Clearing threshold is irrelevant for financial counterparties when analysing the scope for the said risk-mitigation techniques, however with respect to the non-financial ones it is useful to differentiate the techniques at issue in two separate groups of obligations:
1) first - which applies irrespective of the clearing threshold, and
2) second - applying only when the clearing threshold is exceeded.
Risk-mitigation techniques applied irrespective of the clearing threshold
Within the first group are the requirements listed in Article 11(1)(a) and (b) of EMIR, namely the obligation to ensure with due diligence that appropriate procedures and arrangements are in place to measure, monitor and mitigate operational counterparty credit risk, including at least:
(a) the timely confirmation, where available, by electronic means, of the terms of the OTC derivative contract;
(b) formalised processes which are robust, resilient and auditable in order to reconcile portfolios, to manage the associated risk and to identify disputes between parties early and resolve them, and to monitor the value of outstanding contracts.
These requirements apply to counterparties that enter into an OTC derivative contract not cleared by a CCP, both financial as well as the non-financial ones and the value of the clearing threshold is irrelevant for them.
Considering another obligation provided for in Article 11(2) of EMIR (i.e. to mark-to-market (or to-model where market conditions prevent marking-to-market) on a daily basis the value of outstanding contracts, there were some ambiguities flowing from the very wording of Article 11(2) of EMIR which, according to the text of the European Parliament legislative resolution of 29 March 2012 on the proposal for a regulation of the European Parliament and of the Council on OTC derivatives, central counterparties and trade repositories (P7_TA-PROV(2012)0106 http://www.europarl.europa.eu/RegData/seance_pleniere/textes_adoptes/provisoire/2012/03-29/0106/P7_TA-PROV%282012%290106_EN.pdf) literally imposed this obligation on “financial counterparties and non-financial counterparties referred to in Article 7”.
Article 7 of EMIR (mentioned in Article 11(2)) relates to conditions for access to a CCP and it was hard to establish what kinds of “non-financial counterparties referred to in Article 7” were in fact subject to marking-to-market obligation.
The text of EMIR published in Official Journal evidences that there occurred a typographical error in the above-mentioned European Parliament legislative resolution of 29 March 2012 and Article 11(2) should correctly mention “non-financial counterparties referred to in Article 10” (Article 10 of EMIR strictly relates to non-financial counterparties above the clearing threshold).
So, finally it is confirmed by the binding legislative text that the said requirement to mark-to-market on a daily basis the value of outstanding contracts provided for in Article 11(2) of EMIR qualifies to the second of the above-differentiated groups i.e. requirements which apply to the non-financial counterparties only when the clearing threshold is exceeded (for other risk-mitigation techniques in that group see further).
Risk-mitigation techniques applied only when the clearing threshold is exceeded (with respect to non-financial counterparties)
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.
The collateralisation requirement does not apply to an intragroup transaction (in the meaning defined at the beginning) 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’ (ESMA is to provide regulatory technical standards to explain what it means).
Further, 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. Considering some important parameters for the said provisions are to be elaborated on by ESMA in regulatory technical standards (including enigmatic notion for “the contracts that are considered to have a direct, substantial and foreseeable effect within the Union”) at this stage of regulatory developments it seems prematurely to enter into further analysis regarding cross-border impact of the said provisions.
Moreover, 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.