|Dispute resolution procedure requirement under EMIR|
Legal basis for the dispute resolution requirements
EMIR requirements with respect to dispute resolution are stipulated in Article 15 of the regulatory technical standards (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 - ‘Commission Delegated Regulation on Clearing Thresholds’ or ‘RTS’)) - see box.
EMIR Regulation in Article 11(1) requires that counterparties that enter into an OTC derivative contract not cleared by a CCP, must have, exercising due diligence, appropriate procedures and arrangements in place to measure, monitor and mitigate operational risk and counterparty credit risk, including at least formalised processes which are robust, resilient and auditable in order to identify disputes between parties early and resolve them.
The said requirement applies equally to:
- financial counterparties, and
The process for setting regulatory requirements for dispute resolution has a broader reach and legislative developments in that regard are not EU-specific (the example: IOSCO Risk Mitigation Standards for Non-centrally Cleared OTC Derivatives FR01/2015 of 28 January 2015 p. 14 - 15).
Both instruments follow broadly the same line, the latter being of a more general nature.
Required frequency of the disputes' reporting
The frequency of the relevant reporting to a competent authority on disputes was doubtful on the ground of the RTS. Due to the absence of explicit legislative language different timelines were proposed (e.g. monthly, quarterly etc.).
The regulatory stance in that regard is, as a minimum, financial counterparties are expected to make a monthly notification of any disputes outstanding in the preceding month, however, national competent authorities may require more frequent reporting of outstanding disputes.
The another potential problem is whether detailed policies and procedures mentioned in Article 15 of the RTS refer to valuation differences at the trade (or contract) level or margin disputes which occur at the portfolio level.
The were presented views that since the portfolio reconciliation requirement included both collateralised and non-collateralised trades the word 'dispute' here referred to valuation differences observed in the reconciliation process.
However, as ESMA clarified, the valuation is the one attributed to each contract in accordance with Article 11(2) of EMIR (the question was: "What is the 'valuation' referred to in Article 15 of the RTS on OTC derivatives?").
The amount or value of outstanding disputes should be calculated and reported on a trade by trade basis whenever possible. However, a portfolio basis may be used if the disputed valuation or collateral, for example initial margin, is calculated at the portfolio level.
There may be also the ambiguity at which point in time the issue of a "dispute" arises and what are the representative characteristics which differentiate a "dispute" from a discrepancy that party expect can be easily resolved at an operational level. It seems that a seriousness of the issue should be taken into account when determining on this question in the EMIR regulatory sense.
Referring to this issue ESMA in its Questions and Answers on EMIR stated that "Counterparties may agree upfront that discrepancies that amount to a value below a pre-defined threshold do not count as disputes. If that is the case, these minor discrepancies would not count as disputes. All the other discrepancies would give rise to disputes and be treated according to Article 15 of the RTS on OTC derivatives."
ESMA has also explained that a dispute in the sense of the provision at issue may be also caused by cashflows settlement breaks.
Parties wishing to implement EMIR dispute resolution requirements into their contractual documentation have at their disposal at least two master agreements:
- the ISDA 2013 Portfolio Reconciliation, Dispute Resolution and Disclosure Protocol published by the International Swaps and Derivatives Association, Inc. (the "ISDA Protocol"), and
- EFET's form of EMIR Risk Mitigation Techniques Agreement (the ERMTA).
As EFET underlines in its Guidance Notes, it is intended that the core obligations under both the ISDA Protocol and the ERMTA are to apply to transactions that are subject to the applicable EMIR obligations, including where those transactions are not documented under an ISDA Master Agreement (in the case of the ISDA Protocol) or an EFET General Agreement (in the case of the ERMTA).
The possibility to include the above standards into other than ISDA and EFET legal documentation may seem a convenient and swift way to cope with EMIR dispute resolution burdens (as well as other EMIR risk mitigation techniques). However, as is also reserved in the EFET's and ISDA's responsibility clauses, market participant is solely responsible for EMIR compliance as well as for safeguarding its own interests.
Besides, the ERMTA text provides an additional argument that the term "dispute" is understood in the EMIR nomenclature in the very specific sense.
As ERMTA Guidance Notes underline, ERMTA dispute identification and resolution procedure "is distinct from, and does not apply in relation to, a 'dispute' which may arise out of or in relation to the ERMTA in general and which is unrelated to the specific requirements emanating as a result of the implementation of EMIR."
As a result of this differentiation, under EFET standard documentation any 'dispute' other than a dispute in the EMIR sense is to be governed by the relevant standard procedure which has been elected by the parties in accordance with the provision of master agreement specifying the the general issues of governing law and dispute resolution.
Also remedies for breach of the ERMTA when it comes to EMIR requirements have been arranged in the specific manner, namely a failure by a party to comply with the obligations set forth in the ERMTA does not amount to a circumstance that permits termination of the EMIR relevant transaction; and neither will such a failure amount to an event of default, termination event, material reason, or any similar such term, which may permit the termination of the EMIR relevant transaction or any other transactions.
Generally, describing responsibility at issue it is useful to mention that under both the ERMTA as well as ISDA Protocol, failure to comply with contractual EMIR risk mitigation techniques requirements, dispute resolution including, does not represent an event of default, termination event or material reason (without prejudice to rights and remedies provided by law).
The effect is, that under the above master agreements we have a bizarre, to some extent, situation of two distinct dispute resolution procedures designed for different purposes, with separate remedies and responsibility for non-compliance. The inter-dependencies of these procedures require more in-depth analysis.
Interesting and useful feature of ERMTA is that parties may choose to apply its terms to transactions that are not EMIR-relevant transactions and to transactions, in respect of which there is some doubt as to whether or not they are embraced by EMIR risk mitigation requirements.
The above-mentioned IOSCO risk mitigation standards contain an express remark (p. 15) that an agreement on a dispute resolution mechanism or process "would not prevent covered entities from pursuing other options for recourse (e.g. arbitration or legal proceedings)".
Starting date for EMIR dispute resolution requirements
ESMA in its Questions and Answers on EMIR clarified dispute resolution requirements apply to the portfolio of outstanding OTC derivative contracts. Therefore as the relevant technical standards entered into force on 15 September 2013, the requirements apply to the portfolio of outstanding contracts as of such date.
Third-country application and equivalence
ESMA in its Questions and Answers on EMIR also observed that Article 11 of EMIR, which provides the basis for these requirements, applies wherever at least one counterparty is established within the EU.
Therefore, where an EU counterparty is transacting with a third country entity, the EU counterparty would be required to ensure that the requirements for dispute resolution are met for the relevant portfolio and/or transactions even though the third country entity would not itself be subject to EMIR.
However, if the third country entity is established in a jurisdiction for which the Commission has adopted an implementing act (under Article 13 of EMIR), the counterparties could comply with equivalent rules in the third country.
The equivalence status to the US dispute resolution legal framework has been granted by the Commission Implementing Decision (EU) 2017/1857 of 13 October 2017 on the recognition of the legal, supervisory and enforcement arrangements of the United States of America for derivatives transactions supervised by the Commodity Futures Trading Commission as equivalent to certain requirements of Article 11 of Regulation (EU) No 648/2012 of the European Parliament and Council on OTC derivatives, central counterparties and trade repositories.
The US counterpart CFTC issued the parallel media report: CFTC Comparability Determination on EU Margin Requirements and a Common Approach on Trading Venues, Release: pr7629-17, October 13, 2017).
The disputes resolution requirements as a operational risk mitigation technique for OTC derivative contracts not cleared by a CCP are added in a section 4s(i) to the Commodity Exchange Act (CEA) by section 731 of the Dodd-Frank Act and apply to swap dealers and major swap participants, as defined in the CEA.
Consequently, it should be noted that the said Commission Implementing Decision (EU) 2017/1857 of 13 October 2017:
- covers the legal, supervisory and enforcement arrangements regarding disputes resolution applicable to swap dealers and major swap participants established in the USA that are authorised and supervised in accordance with the CFTC Regulations;
CFTC Regulations on operational risk mitigation techniques for OTC derivative contracts not cleared by a CCP contain similar obligations to those provided for in Article 11(1) EMIR.
In particular, Subpart I of Part 23 of the CFTC Regulations contains specific detailed requirements regarding, among others, disputes resolution applicable to OTC derivative contracts not cleared by a CCP.
Taking into account the limited impact due to the difference in scope of the requirements for agreements on how disputes are resolved, the requirements set out in the CFTC Regulation are considered equivalent to the requirements of the EMIR Regulation on dispute resolution.
The said Commission Decision (EU) 2017/1857 concludes in Recital 9 that in relation to swaps that are under the jurisdiction of the CFTC, as defined in section 1a(47) of the CEA, the CFTC's legal, supervisory and enforcement arrangements applicable to swap dealers and major swap participants are equivalent to the disputes resolution requirements set out in the EMIR applicable to OTC derivative contracts not cleared by a CCP, as laid down in Article 11(1) EMIR.
The effect of the above statement is that market participants are allowed to comply with only one set of rules and to avoid duplicative or conflicting rules, i.e. where at least one of the counterparties is established in the US, it is deemed to have fulfilled EMIR disputes resolution requirements by complying with the requirements set out in the US legal regime.
However, it is noteworthy, the CFTC’s equivalence determination applies only where both the entity and the transaction are otherwise subject to both the CFTC and EU dispute resolutions regulations, and not when a swap dealer voluntarily complies with the respective regime.
On 25 April 2019 the European Commission adopted Commission Implementing Decision (EU) 2019/684 of 25 April 2019 on the recognition of the legal, supervisory and enforcement arrangements of Japan for derivatives transactions supervised by the Japan Financial Services Agency as equivalent to the valuation, dispute resolution and margin requirements of Article 11 of Regulation (EU) No 648/2012 of the European Parliament and Council on OTC derivatives, central counterparties and trade repositories.
Special treatment for C6 energy derivatives contracts
Pursuant to MiFID II Directive EMIR timely confirmation requirements will not apply during the 42-month transitional period (counted from the entry into application of the said Directive) to C6 energy derivatives (i.e. physically settled coal and oil traded on an OTF) entered into:
- by non-financial counterparties below EMIR clearing threshold, or
- by non-financial counterparties that will be authorised for the first time as investment firms as from the date of entry into application of the MiFID II.
It is noteworthy that the particular term appears in the language of Article 15 of RTS namely five business days as a deadline above which the process should be "specific". This is a new issue to include in the drafting for the contracts.
25 April 2019
Commission Implementing Decision (EU) 2019/684 of 25 April 2019 on the recognition of the legal, supervisory and enforcement arrangements of Japan for derivatives transactions supervised by the Japan Financial Services Agency as equivalent to the valuation, dispute resolution and margin requirements of Article 11 of Regulation (EU) No 648/2012 of the European Parliament and Council on OTC derivatives, central counterparties and trade repositories
EMIR Regulation, Article 11(1)
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, Article 15
Commission Implementing Decision (EU) 2017/1857 of 13 October 2017 on the recognition of the legal, supervisory and enforcement arrangements of the United States of America for derivatives transactions supervised by the Commodity Futures Trading Commission as equivalent to certain requirements of Article 11 of Regulation (EU) No 648/2012 of the European Parliament and Council on OTC derivatives, central counterparties and trade repositories.
|Last Updated on Thursday, 30 May 2019 20:08|