|Concerns regarding allocation of responsibility when calculating clearing thresholds under EMIR|
|Saturday, 23 March 2013 14:54|
Among potential compliance concerns regarding EMIR and particularly the issue of clearing thresholds is the question how the counterparty trading with the non-financial counterparty (NFC) is going to be made aware that the NFC has or has not yet exceeded the clearing threshold and how the responsibility for breaching the respective restrictions is shared.
The relevant questions, amongst others, are:
1) Under what conditions the counterparty of the NFC may be held liable for the effects of NFC’s breaching clearing threshold and what extent of the diligence is required of the said counterparty by law?
2) Is the representation made by the NFC in the signed-off agreement about the absence of legal impediments for the valid conclusion of the agreement sufficient for effective exculpation?
3) Is the “common sense” pattern the only standard in that regard or there are other that should be complied with by market parties?
In that regard it was strongly underlined by the industry that:
“The uniform identification of counterparties as FCs, NFC+ or NFCs is central to the consistent cross-market implementation of individual firms’ policies and procedures designed to meet the reconciliation requirements established under EMIR. In the absence of industry sources or a requirement to make counterparty representation mandatorily available, firms will need to rely on counterparty representation and internal reference data which could lead to inconsistent treatment of firms, particularly as it relates to the distinction between NFC and NFC+ where the reconciliation threshold and frequency are quite different, depending upon counterparty categorization. It would be extremely beneficial if ESMA (to whom the relevant report by an NFC breaching the clearing threshold is made, in the first instance) could make this information centrally available to the industry in a way that the information can be relied upon and give certainty to those dealing with firms as to how they should be categorised. It should also be noted that the CFTC makes registered firm classifications available to the public via the National Futures Association (NFA) website”
(see: ISDA Commentary on EMIR RTS on Portfolio Reconciliation, Dispute Resolution and Compressions (in European Commission Delegated Regulation C92012) 9593 final (19 December 2012)) of 14 February 2013, http://www2.isda.org).
The problem has been noted by the regulatory authorities and there is currently available the clarification from ESMA dated 20 March 2013 on the issue whether the financial counterparty is responsible for the proper qualification of its counterparty as being above or below the clearing threshold.
The ESMA's answer is as follows:
"NFCs which trade OTC derivatives are obliged to determine their own status against the clearing threshold. FCs should obtain representations from their NFC counterparties detailing the NFC’s status. FCs are not expected to conduct verifications of the representations received from NFCs detailing their status and may rely on such representations unless they are in possession of information which clearly demonstrates that those representations are incorrect."
The above language indicates that the obligation to verify the counterparty position versus clearing threshold has been imposed on market participants to a certain extent, however, the relevant check need not to be thorough. At a minimum the necessary audit should cover two points:
1) whether the relevant representation was made, and
2) whether the entity is in possession of information which "clearly demonstrates that those representations are incorrect."
However, as always, every clarification rises further ambiguities. In this case the said further doubt may be for instance, whether the assessment referred to above in point 2 should be made on the entire group level or from the perspective of the subsidiary company only? In other words, will the subsidiary company be lawfully discharged from liability for the incorrect assessment of its counterparty clearing-threshold status if the meaningful documents are cognizant of by its head office only? The said ambiguity is raised by the general EMIR's approach to groups of associated companies which in certain issues are treated as a single entity (in particular when it comes to evaluation whether the clearing threshold has been crossed).
Another key concerns are:
1) the effects of NFC’s inadvertent crossing the threshold as a result of non-EUR denominated contracts moving in or out of EUR value threshold due to FX movements;
2) the issue if the 30 day rolling average mean the notional value of outstanding trades over the previous 30 days or the notional value of new trades done in the previous 30 days;
3) the point in time where the above assessments of legally-relevant features of hedge transaction should be made – especially whether a trade should depend upon the NFC’s intentions when entering into the trade or retrospective estimations should be given priority.
Also the detailed manner of the clearing threshold calculating rises some doubts. In that regard further analysis require:
- transactions traded over regulated venues,
- positions which are to be netted under netting agreements,
- collateralised derivatives positions,
- any intra-group derivative transaction once the general exemption for these transactions has been granted to a non-financial firm.