Delegate Pack 14 May Documents

Transcription

1 European Market Infrastructure Regulation ( EMIR ) Current Status and Future Developments Delegate Pack 14 May 2015 Documents 1. EMIR: Presentation 2. EMIR: An Overview 3. EMIR: The Proposed European Regulation on o Derivatives, Central Counterparties and Trade Repositorie es 4. EMIR: The Final Adopted Regulatory Technical Standards 5. EMIR: Key Facts about Margining 6. EMIR: EMIR and its extraterritorial applicability 7. CMS EMIR Team Further information, including a list of our offices, can be foundd at CMS Cameron McKenna LLP 2015.

2 European Market Infrastructure Regulation (EMIR): Current Status and Future Developments Jason Harding Eva Valentova

3 Agenda 1. Overview of EMIR 2. Who is in scope? 3. EMIR implementation timeline 4. What is already live? 5. What is coming into force? 6. Expected developments 2

4 1. Overview of EMIR EU regulation concerning OTC derivatives, central counterparties and trade repositories Adopted as a response to the G20 commitments made in 2009 following the financial crisis and the AIG and Lehman collapses Effective as of 16 August 2012 in all member states, without the need for any national legislation Framework legislation detailed implementing rules contained in regulatory technical standards (RTS) developed by the European Securities & Markets Authority (ESMA) 3

5 1. Overview of EMIR (cont.) EMIR imposes four main obligations on derivatives market counterparties in the EU: Obligation on a non-financial counterparty to notify competent authority immediately (= on the first day) if over clearing threshold Mandatory clearing of certain types of OTC derivatives via a central counterparty (CCP) Implementation of risk mitigation techniques in relation to any OTC derivatives that are not cleared, including arrangements for timely confirmation; portfolio reconciliation, portfolio compression and dispute resolution; daily valuation of outstanding OTC derivative contracts and margining Mandatory reporting of all derivatives (OTC and ETD) to a trade repository (TR) 4

6 2. Who is in scope? Entity types Financial counterparties (FCs): broadly, credit institutions, investment firms, insurers/reinsurers, UCITS/UCITS managers, pension schemes, alternative investments funds (AIFs) managed by AIFMs, in each case authorised or registered in accordance with the relevant EU directive Non-financial counterparties (NFCs): all undertakings established in the EU which are not FCs; NFCs whose OTC derivatives exceed certain clearing thresholds are referred to as NFC+ Counterparties outside the EU (third country entities or TCEs): may be subject to the clearing and risk mitigation obligations under EMIR Exempt: EU central banks, public bodies dealing with public debt and Bank for International Settlements 5

7 2. Who is in scope? Third country entities (TCEs) TCEs may be subject to the clearing and risk mitigation obligations under EMIR EMIR can affect TCEs directly and indirectly The direct effect of EMIR on TCEs is a consequence of the RTS on direct, substantial and foreseeable effect of contracts within the Union and to prevent the evasion of rules and obligations (Commission Delegated Regulation (EU) No 285/2014) 6

8 2. Who is in scope? Extra-territoriality Art. 3 of EMIR (in force 10 April 2014) Covers OTC derivative contracts that lack a clear business rationale or economic justification in order to evade the application of EMIR Art. 2 of EMIR (in force 10 October 2014) A contract will have a direct, substantial and foreseeable effect within the EU where: at least one TCE benefits from a guarantee from an EU FC above a certain cumulative threshold; or two TCEs enter an OTC derivative contract through their branches in the EU, provided the TCEs would qualify as FCs if established in the EU TCEs are encouraged to notify their counterparties if they have an EU FC guarantor 7

9 2. Who is in scope? Extra-territoriality (cont.) Cumulative thresholds a guarantee will qualify if: it covers liability under one or more OTC derivative contracts for an aggregated notional amount of at least 8 billion (or part of such liability, in which case this threshold should be reduced proportionally); and it is at least equal to 5 per cent. of the EU guarantor s total current exposures (as defined in the Capital Requirements Directive) under OTC derivative contracts Liability that arises from OTC derivative contracts must reach the 8 billion threshold for the guarantee to be at risk of qualifying Applicability of the thresholds is to be considered on an ongoing basis TCEs may be directly subject to clearing and risk mitigation obligations under EMIR in the following circumstances: the clearing obligation will apply directly to a TCE that would be subject to the clearing obligation if it were established in the EU when it enters into OTC derivative contracts with FCs/NFCs+ the requirement to use certain risk mitigation techniques extends to all counterparties 8

10 2. Who is in scope? Equivalence Art. 13 of EMIR is designed to avoid duplicative or conflicting rules If at least one TCE is established in an equivalent jurisdiction, the parties can adhere to the rules of that jurisdiction rather than EMIR TCEs in non-equivalent jurisdictions must ensure EMIR compliance The European Commission (EC) has mandated ESMA to provide technical advice on regimes in: Australia, Canada, Hong Kong, Japan, India, Singapore, South Korea, Switzerland and the United States 9

11 2. Who is in scope? Cross-border EMIR bites in cross-border transactions between a TCE and an EU counterparty Clearing obligation: affects both the EU FC/NFC+ and the TCE that would be subject to the obligation if established in the EU the market view is that responsibility lies with an EU counterparty to ensure compliance Risk mitigation: obligation applies even if the TCE would not be subject to EMIR burden is on EU counterparty to ensure compliance by agreeing measures with its TCEs 10

12 3. EMIR implementation timeline Q1: First CCP authorised Q4 1 st Clearing Obligation Category 1 Q4 1 st Clearing Obligation Category 3 Q2 1 st Clearing Obligation Category 4 Q2 1 st Clearing Obligation RTS published in OJ Q2 1 st Clearing Obligation Category Q1: Timely Confirmations Daily valuations NFC+ notification Q3: Portfolio reconciliation Portfolio compression Dispute resolution Q1: / Q3: 12 February / 11 August Reporting to TRs Q3: Phase in of variation margin and initial margin Note: Presupposes (i) ESMA delivers revised draft RTS in Q1 2015, the EC adopts the revised draft RTS in Q and the Council/Parliament do not object and do not extend their three (3) month objection period and (ii) the margin RTS are endorsed by the EC in the form proposed during the consultation phase. 11

13 4. What is already live? 15 March 2013 NFC notification (Art. 10 of EMIR): NFCs must immediately notify the competent authority (ie, in the UK, FCA) if their (and their non-financial affiliates ) positions in OTC derivative contracts of the same asset class (excluding hedging positions) exceed/no longer exceed specified clearing thresholds in respect of such class Timely confirmations (Art. 11(1) of EMIR): OTC derivative contracts between in scope counterparties must be confirmed by T+1 for contracts between FCs/NFC+ and T+2 for contracts with a NFC- FCs must have procedures for monthly reporting of unconfirmed transactions Daily valuation (Art. 11(2) of EMIR): FCs and NFC+ must carry out daily mark-to-market valuations or, where market conditions prevent this, mark-to-model valuations 12

14 4. What is already live? (cont.) 15 September 2013 Portfolio reconciliation (Art. 11(1) of EMIR): FCs and NFCs must agree processes for regular portfolio reconciliation with counterparties, in frequencies as follows: FC/NFC+: each business day (if OTC derivative contracts outstanding); weekly (if OTC derivative contracts outstanding per week); quarterly (if up to 50 OTC derivative contracts outstanding per quarter) NFC-: quarterly (if 100+ OTC derivative contracts outstanding per quarter); annually (if up to 100 OTC derivative contracts outstanding) Portfolio compression (Art. 11(1) of EMIR): FCs and NFCs must have processes in place to take advantage of opportunities where transactions can be terminated and replaced with an OTC derivative contract of a lower combined notional value Dispute resolution (Art. 11(1) of EMIR): FCs and NFCs must agree procedures for identifying, recording, monitoring and resolving of disputes; FCs must report unresolved disputes to the competent authority (ie. FCA) 13

15 4. What is already live? (cont.) 12 February 2014 / 11 August 2014 Reporting to TRs (Art. 9 of EMIR): When: Counterparties must report all of their contracts (OTC and ETD) to a registered or recognised TR or to ESMA by T+1 Delegation: Counterparties may delegate the reporting to a third party but retain responsibility for the reporting obligation TRs: Six TRs authorised so far: DDRC, REGIS-TR, CME TR, KDPW, ICE TVEL, UnaVista What needs to be reported: (1) Common Data, including main characteristics of the trade such as the type of derivative, underlying, maturity, notional value, price and settlement data, economic terms and trade identifiers; (2) Counterparty Data, including counterparty classification, beneficiary information and legal entity identifiers of the parties; (3) Collateral and Valuation Data, FCs and NFC+ have to report the daily mark-to-market (or mark-to-model) value as well as the value of collateral posted 14

16 4. What is already live? (cont.) When did the reporting obligation start: 12 February 2014 for Common Data and Counterparty Data 11 August 2014 for Collateral and Valuation Data Contracts (OTC and ETD) outstanding on 16 August 2012 and still outstanding on 12 February 2014 (the reporting start date) had to be reported within ninety (90) days of the reporting start date Contracts (OTC and ETD) entered into (i) before 16 August 2012 (and still outstanding on 16 August 2012); and (ii) on or after 16 August 2012, but in each case not outstanding on or after the reporting start date, must be reported within three (3) years of the reporting start date LEI: Counterparties should obtain a global legal entity identifier (LEI) when available for the purpose of reporting Counterparty Data (by registering with a pre-lou (Local Operating Unit), ie. GMEI Utility) 15

17 4. What is already live? (cont.) Checklist FC Confirm uncleared OTC derivative contracts by T+1 Following conclusion of an uncleared OTC derivative contract Prepare a report on unconfirmed uncleared OTC derivative contracts for more than five (5) business days Monthly (to be provided to the competent authority upon request only) Calculate mark to market/mark to model valuation of uncleared OTC derivative contracts daily Ongoing Obtain a Legal Entity Identifier (LEI) Agree processes with counterparties for portfolio reconciliation with respect to uncleared OTC derivative contracts: - Each business day (if 500+ outstanding uncleared OTC derivative contracts) - Weekly (if outstanding uncleared OTC derivative contracts per week) - Quarterly (if up to 50 outstanding uncleared OTC derivative contracts per quarter) Ensure processes are in place to take advantage of portfolio compression opportunities (vis à vis counterparties where 500+ uncleared OTC derivative contracts are outstanding). At least twice a year analyse the possibility to conduct a portfolio compression and, if appropriate, carry out the same Agree processes with counterparties to uncleared OTC derivative contracts to identify, record, monitor and resolve disputes on reported portfolio data Report unresolved disputes with respect to uncleared OTC derivative contracts for an amount higher than EUR 15million and outstanding for at least 15 business days to the competent authority (ie. FCA) Report trade data to a TR (or ESMA if no TR available) by T+1 Before reporting derivative contracts (OTC and ETD) Before trading Ongoing Before trading Following disputes Following conclusion, termination or modification of a derivative contract (OTC and ETD) 16

18 4. What is already live? (cont.) Checklist (cont.) NFC+ Assess whether positions in OTC derivatives contracts (excluding contracts for hedging purposes) exceed/cease to exceed clearing threshold and notify competent authority (ie, FCA) immediately of change Confirm uncleared OTC derivatives contracts by T+1 Calculate mark to market/mark to model valuation of uncleared OTC derivative contracts daily Obtain a Legal Entity Identifier (LEI) Agree processes with counterparties for portfolio reconciliation with respect to uncleared OTC derivative contracts: - Each business day (if 500+ outstanding contracts) - Weekly (if outstanding contracts per week) - Quarterly (if up to 50 outstanding contracts per quarter) Ensure processes are in place to take advantage of portfolio compression opportunities (vis à vis counterparties where 500+ uncleared OTC derivative contracts are outstanding). At least twice a year analyse the possibility to conduct a portfolio compression and, if appropriate, carry out the same Agree processes with counterparties to uncleared OTC derivative contracts to identify, record, monitor and resolve disputes on reported portfolio data Report trade data to a TR (or ESMA if no TR available) by T+1 Delegate authority to report trade data to a third party (optional) Ongoing Following conclusion of an uncleared OTC derivative contract Ongoing Before reporting derivative contracts (OTC and ETD) Before trading Ongoing Before trading Following conclusion, termination or modification of a derivative contract (OTC and ETD) Ongoing 17

19 4. What is already live? (cont.) Checklist (cont.) NFC Assess whether positions in OTC derivatives contracts (excluding contracts for hedging purposes) exceed/cease to exceed clearing threshold and notify competent authority (ie. FCA) immediately of change Confirm uncleared OTC derivatives contracts by T+2 Obtain a Legal Entity Identifier (LEI) Agree processes with counterparties for portfolio reconciliation with respect to uncleared OTC derivative contracts: - Quarterly (if 100+ outstanding contracts per quarter) - Annually (if up to 100 outstanding contracts per quarter) Ensure processes are in place to take advantage of portfolio compression opportunities (vis à vis counterparties where 500+ uncleared OTC derivative contracts are outstanding). At least twice a year analyse the possibility to conduct a portfolio compression and, if appropriate, carry out the same Agree processes with counterparties to uncleared OTC derivative contracts to identify, record, monitor and resolve disputes on reported portfolio data Report trade data to a TR (or ESMA if no TR available) by T+1 Delegate authority to report trade data to a third party (optional) Ongoing Following conclusion of an uncleared OTC derivative contract Before reporting derivative contracts (OTC and ETD) Before trading Ongoing Before trading Following conclusion, termination or modification of a derivative contract (OTC and ETD) Ongoing 18

20 5. What is coming into force? Margining Margining of uncleared OTC derivative contracts Art. 11(3) of EMIR On 14 April 2014, the European Supervisory Authorities (ESAs) (ie. EBA, ESMA and EIOPA) published a consultation paper on the exchange of margin for uncleared OTC derivative contracts, proposing a start date of 1 December 2015 (subject to the phase-in requirements for initial margin) Initially, ESAs expected to deliver the final draft RTS to the EC by end of 2014 To date, the final rules have not yet been published by European, US and Japanese authorities 19

21 5. What is coming into force? Margining (cont.) Determining applicable margin rules Counterparties will need to consider and determine: Which (if any) margin regulations apply (based on the relevant cross-border rules) Scope of application of relevant margin rules: (A) not applicable or (B) VM only or (C) VM and IM Key information to make such determination: Parties status under each of the margin regulations Parties average aggregate notional amount (AANA) under each of the margin regulations Relationship-specific information (eg, domicile of a guarantor) To assist in obtaining the necessary information, ISDA is developing a self-disclosure form (to be available on ISDA Amend) in particular, this form will contain information as to (1) a party s status under various margin regulations, (2) affiliates and (3) whether the AANA thresholds have been crossed under various margin regulations (tracking will need to be done on a group basis) 20

22 5. What is coming into force? Margining (cont.) Draft RTS key concerns Non-EU NFC-s and sovereigns: non-eu entities that would not qualify as FCs or NFC+s and non-eu sovereigns should not be required to post margin Initial margin models: a number of model requirements are overly rigid and prescriptive Concentration limits: too restrictive Timing and VM phase-in: at least two (2) years (from the adoption of final rules) needed for the implementation of the margin requirements and the ESAs should phase in the requirement to post VM Documentation: documentation requirements (particularly the requirement to enter into agreements with NFC-s) are overly burdensome International consistency / cross-boarder issues: margin rules should be consistent across the major financial jurisdictions 21

23 5. What is coming into force? Margining (cont.) Draft RTS overview Applicable prospectively Five chapters: Counterparties risk management procedures Margin methods Eligibility and treatment of collateral Operational procedures Procedures concerning intra-group OTC derivative contracts 22

24 5. What is coming into force? Margining (cont.) Counterparties risk management procedures general Collection of Initial Margin (IM) collected to cover potential future exposure to the other counterparty providing the margin in the interval between the last margin collection and the liquidation of positions following a default of the other counterparty on gross basis (ie. IM amounts cannot be netted against each other) Collection of Variation Margin (VM) collected to reflect current exposures resulting from actual changes in market price on net basis Parties should agree eligible collateral upfront 23

25 5. What is coming into force? Margining (cont.) IM Extension: 1 December September 2016 Phase-in: from 1 September 2016 to 1 September 2020 Must be collected within one (1) business day of the execution of a new OTC derivative contract The total amount of IM collected from another counterparty must be recalculated and collected when: a new contract is executed with that counterparty; an existing contract with that counterparty expires; an existing contract triggers a payment (or delivery) other than posting or collecting VM; or no IM recalculation has been performed in the last ten (10) business days 24

26 5. What is coming into force? Margining (cont.) IM phase-in thresholds From 1 September 2016 Threshold Amount trillion trillion trillion trillion billion Note: The Threshold Amount is to apply at a consolidated group level with respect to average aggregate notional amounts of uncleared OTC derivative contracts for March, April, May of the relevant year. 25

27 5. What is coming into force? Margining (cont.) VM Extension: 1 December September 2016 Phase-in: 1 September 2016 (covered entities above 3 trillion); 1 March 2017 (all other covered entities) Must be collected at least on a daily basis starting from one (1) business day after the execution of the OTC derivative contract Based on the mark-to-market valuation of transactions under outstanding OTC derivative contracts (Art. 11(2) of EMIR and Arts. 16 and 17 of RTS) 26

28 5. What is coming into force? Margining (cont.) Counterparties risk management procedures specific Counterparties may agree not to collect IM with respect to: physically settled foreign exchange forwards and swaps exchange of principal of a currency swap FCs may agree with their FC or NFC counterparties that IM will not be exchanged if the total amount of margin exchanged is less than 50 million, provided capital will be held against the party s exposure to its counterparty. Threshold covers all IM to be exchanged between counterparties at group level Counterparties may reduce the amount of IM exchanged by the value of the margin threshold Full amount of VM to be exchanged with no applicable threshold 27

29 5. What is coming into force? Margining (cont.) Counterparties risk management procedures specific (cont.) Counterparties may agree a minimum transfer amount of 500,000 covering all IM and VM and excess collateral (if any) FCs/NFC+s may agree not to collect IM or VM from NFC-s and/or counterparties exempt from EMIR Counterparties may agree that IM and VM are not posted by covered bond issuers and cover pools if certain conditions are met, including: derivative must not terminate in case of default of the covered bond issuer; legal overcollateralisation of at least 102%; and derivative used only for hedging purposes 28

30 5. What is coming into force? Margining (cont.) Margin methods Standardised method Annex IV of the draft RTS Notional amounts or underlying values of the OTC derivative contracts are multiplied by the relevant haircuts dependent, essentially, upon residual maturity Initial margin models May be developed by a counterparty or jointly by the two counterparties or by a third party agent No industry-wide common approach to modelling Counterparties must notify the relevant competent authority (ie, FCA) if they are intending to use an initial margin model ISDA is leading industry efforts to develop a standard model for calculating IM 29

31 5. What is coming into force? Margining (cont.) Initial margin models requirements Calibration of the model based on historical data from a period of at least three (3) years at least 25% of stressed data recalibration at least every six (6) months Primary risk factor and underlying classes IM to be calculated first at underlying class level total IM = sum of IM calculated for each underlying class Assessments of the validity of the model s risk assessments initial validation by independent parties at least annually a process for verifying at least annually that the netting agreements considered for IM calculation are legally enforceable clear documentation showing all changes to the initial margin model and the tests performed 30

32 5. What is coming into force? Margining (cont.) Eligibility and treatment of collateral Covers asset classes listed in the draft RTS cash; gold; debt securities issued by central governments, central banks, public sector entities, credit institutions, investment firms; corporate bonds; equities; shares or units in UCITS Requirement for credit quality assessment in relation to certain asset classes using one of the methodologies specified in the draft RTS: internal models ( internal-ratings-based approach (if authorised)) external credit assessments Specific eligibility criteria apply to certain asset classes 31

33 5. What is coming into force? Margining (cont.) Eligibility and treatment of collateral (cont.) Limits on the concentration of collateral type for IM and VM will apply no limits applicable to cash concentration limits of 10%, 40% and 50% Haircuts applicable to market value of collateral standard methodology in Annex II of RTS (0.5% 24%, depending in particular upon the residual maturity and the type of securities) own estimates subject to criteria in Annex III of RTS 32

34 5. What is coming into force? Margining (cont.) Operational procedures Exchange of collateral: a detailed documentation of policy (covering collateral levels, types and eligibility, applicable haircuts) updated at least annually processes for escalation of disputes with counterparties counterparties must agree in writing the terms of the operational process for the exchange of collateral (including any segregation arrangements, settlement of margin calls, methods for calculating and valuing collateral etc.) procedures to periodically verify the liquidity of the eligible collateral Segregation of IM No ability to re-hypothecate, re-pledge or otherwise re-use IM 33

35 5. What is coming into force? Margining (cont.) Procedures concerning intra-group OTC derivative contracts Intra-group exemption (Art. 11(6) (10) of EMIR) regular monitoring of intra-group exposures and the timely settlement of the obligations arising out of intra-group OTC derivative contracts Avoid current or foreseen practical or legal impediments to the prompt transfer of own funds or repayment of liabilities between the counterparties by: maintaining sufficient assets to satisfy transfers or repayments when due (no operational obstacles etc.); and ensuring no restrictions under the applicable laws or any relevant contractual relationships (the absence of currency or exchange controls, regulatory restrictions, limitation on the ability to transfer funds etc.) 34

36 5. What is coming into force? Margining (cont.) Documentation ISDA Working Group on Margining Requirements (WGMR) A new suite of collateral documentation required that will need to address different (and potentially inconsistent) margin regulations New ISDA templates for Credit Support Documents being developed Contractual Architecture: (1) existing CSA, (2) new CSA for regulatory VM and nonregulatory IM (if posted), (3) (after the transition to regulatory IM) new Credit Support Documents for regulatory IM Parties using English law documentation would use a title-transfer CSA for VM and a separate CSD for segregated (regulatory) IM Custodial agreements (tri-party agreements) will be required in light of the requirement for segregation of IM New or updated netting opinions may be necessary for counterparties in certain jurisdictions 35

37 5. What is coming into force? Margining (cont.) Checklist Establish/obtain the total gross notional values of uncleared OTC derivative contracts at a group level, in order to determine if the IM/VM is likely to apply in light of the phase in thresholds Before margining obligation comes into force Identify a possibility to agree an opt out, in particular consider: - whether margin should be exchanged where the total collateral amount is equal to or lower than 500,000 - whether the total amount of IM to be exchanged would be likely to be equal to or less than 50mm at a group level - the position with respect to uncleared physically settled FX swaps/forwards or the exchange of principal on uncleared currency swaps (in each case, if any) Review existing collateral arrangements with respect to uncleared OTC derivative contracts and, if required, repaper as appropriate Review infrastructure and operational capabilities to ensure compliance with any operational requirements set out in EMIR (and related RTS) with respect to margining. Note that: - VM: first collected by T+1, then on a daily basis; calculated based on a daily valuation of the relevant uncleared OTC derivative contract - IM: first collected by T+1, then recalculated each 10th business day or following certain events Establish/regularly revisit internal risk management procedures that are sufficiently robust to ensure timely exchange of margin and otherwise meet requirements set out in EMIR (and related RTS) with respect to margining Establish/regularly revisit appropriate segregation arrangements with respect to IM to ensure compliance with specific requirements set out in EMIR (and related RTS). If margin is to be held by the collecting counterparty, discuss the ways how it will be segregated from the assets of other posting counterparties Obtain legal opinions in all relevant jurisdictions on whether the segregation arrangements meet the requirements set out in EMIR (and related RTS) Discuss and agree in writing whether IM will be calculated according to the Standardised Method or using the Initial Margin Model Before margining obligation comes into force Before margining obligation comes into force Ongoing Ongoing (and at least annually) Ongoing At the inception of an uncleared OTC derivative contract and then annually Ongoing 36

38 5. What is coming into force? Clearing What is clearing? Original OTC derivative contract between two counterparties is replaced by two new contracts with a CCP Only clearing members (CM), who comply with strict membership criteria, can clear through a CCP Generally, counterparties will become a client of a CM who will act as a clearing broker 37

39 5. What is coming into force? Clearing (cont.) Who is in scope? Counterparties required to clear all OTC derivative contracts between FCs/NFC+s (and TCEs) (Art. 4 of EMIR) NFC+ = NFCs whose average notional positions in OTC derivative contracts over 30 working days exceed certain clearing thresholds in any derivatives asset class (other than derivatives for hedging purposes as defined below) are referred to as NFC+ and required to clear in all classes Clearing Thresholds Type of OTC derivatives transaction Gross Notional Value Credit derivatives 1 billion Equity derivatives 1 billion Interest rate derivatives 3 billion Foreign exchange derivatives 3 billion Commodity derivatives and other 3 billion asset classes 38

40 5. What is coming into force? Clearing (cont.) What is in scope? OTC derivative contracts pertaining to an asset class which is subject to the clearing obligation which will be entered into or novated either: on or after the date of the clearing obligation takes effect; or between the date of notification to ESMA, but before the date the clearing obligation takes effect if the OTC derivative contracts have a remaining maturity higher than the minimum remaining maturity (MRM) determined by the EC (Frontloading) OTC derivative contracts for hedging purposes are not in scope for the clearing threshold when determining the NFC category: objectively measurable as reducing risks directly relating to the commercial activities or treasury financing activities of an NFC or its group only needs to constitute a hedge at time of entry into transaction 39

41 5. What is coming into force? Clearing (cont.) Exemptions Intra-group (including a TCE) OTC derivative contracts. The EC proposed that third countries be deemed equivalent until the earlier of (i) three (3) years from the date of the first clearing RTS; or (ii) a decision is adopted on the equivalency of the third country concerned. However, ESMA has challenged the legal basis for this decision OTC derivative contracts associated with covered bond programmes Pension schemes until August

42 5. What is coming into force? Clearing (cont.) Key concepts Margin IM is retained by CCP; VM is paid by the CCP to the CM in the money CM may need to convert or exchange ineligible collateral Segregation Client can choose level of segregation: Individual client account Omnibus client account Portability If the CM defaults, the CCP is obliged to: transfer the positions and assets relating to the client to a new CM ( porting ) if porting is not possible, attempt to return the assets directly to the client Relationships with at least two CMs is recommended 41

43 5. What is coming into force? Clearing (cont.) Current position ESMA has published three consultation papers: OTC interest rate derivative classes and OTC equity, interest rate futures and options derivative classes OTC credit derivative classes OTC foreign exchange non-deliverable forward derivative class Other asset classes (such as OTC commodity derivatives) to be covered in subsequent consultation papers On 1 October 2014, ESMA submitted to the EC a draft RTS in relation to in scope OTC interest rate derivative classes. On 6 January 2015, the EC endorsed the draft RTS with amendments and returned it to ESMA. On 29 January 2015, ESMA delivered to the EC an opinion with revised RTS and on 9 March 2015, ESMA delivered a revised opinion but did not make any material changes 42

44 5. What is coming into force? Clearing (cont.) Consultation no.1 OTC interest rate derivative classes in scope: Types: float-to-float swaps (basis swaps), fixed-to-float interest rate swaps (plain vanilla IRS), forward rate agreements and overnight index swaps Characteristics: floating reference rate, settlement currency, currency type, maturity, existence of embedded optionality and notional amount type CCPs: Nasdaq OMX (Sweden), Eurex Clearing AG (Germany), LCH.Clearnet Limited (UK) and CME Clearing Europe Limited (UK) out of scope: CCP: KDPW_CCP is only authorised for OTC interest rate swaps denominated in Polish Zloty 43

45 5. What is coming into force? Clearing (cont.) Consultation no.1 OTC equity, interest rate futures and options derivative classes out of scope OTC Interest rate future and option derivative classes cleared by Nasdaq OMX (Sweden) and LCH.Clearnet Limited (UK) OTC equity derivative classes cleared by Nasdaq OMX (Sweden) and LCH.Clearnet Limited (UK) 44

46 5. What is coming into force? Clearing (cont.) Consultation no.2 OTC credit derivative classes in scope Type: European untranched index credit default swaps CCPs: LCH.Clearnet SA (France) (with ICE Clear Europe expected to be authorised by the time the RTS enters into force) out of scope Type: single name credit default swaps CCPs: Nasdaq OMX (Sweden) and LCH.Clearnet SA (France) Phase-in periods, categories of counterparties and MRM are likely to mirror the position taken in respect of OTC interest rate derivative classes Draft RTS to be submitted shortly (ESMA delayed submission in order to allow the EC to assess the draft RTS in respect of OTC interest rate derivative classes) 45

47 5. What is coming into force? Clearing (cont.) Consultation no.3 OTC foreign exchange non-deliverable forward derivative class (NDFs) in scope Type: cash settled foreign exchange forward contracts Characteristics: currency pair, settlement currency, settlement type, maturity CCPs: LCH.Clearnet Limited (UK) Following feedback on the consultation paper, ESMA is not proposing a clearing obligation in respect of NDFs 46

48 5. What is coming into force? Clearing (cont.) Proposed timetable and categories of counterparties Category 1 6 month phase-in period after entry into the RTS Entities which are, at the date the RTS comes into force: clearing members of at least one CCP authorised to clear at least one of the classes subject to the clearing obligation; and their clearing membership allows it to clear at least one of the classes subject to the clearing obligation Category 2 12 month phase-in period after entry into the RTS FCs and AIFs (that are NFC+) not included in Category 1 which belong to a group whose aggregate month-end average notional amount outstanding of uncleared OTC derivative contracts for (three months after the publication of the RTS in the Official Journal) is above 8 billion 47

49 5. What is coming into force? Clearing (cont.) Category 3 18 month phase-in period after entry into the RTS FCs and AIFs (that are NFC+) not included in Category 1 or 2 Category 4 3 year phase-in period after entry into the RTS NFC+ not included in Category 1, 2 or 3 If an OTC derivative contract is entered into between counterparties in different categories, the date the clearing obligation will take effect is the later of the two Example: a FC in Category 1 will not be required to clear an OTC derivative contract with a NFC+ in Category 4 until three (3) years after the RTS enters into force 48

50 5. What is coming into force? Clearing (cont.) Clearing implementation timeline Q3 RTS due to come into force (20 days after publication in the Official Journal) Q1 End of 6 month phase in period for Category 1 counterparties Q3 End of 12 month phase in period for Category 2 counterparties Q1 End of 18 month phasein period for Category 3 counterparties Q3 End of 3 year phase in period for Category 4 counterparties Note: Presupposes (i) ESMA delivers revised draft RTS in Q1 2015, the EC adopts the revised draft RTS in Q and the Council/Parliament do not object and do not extend their three (3) month objection period. 49

51 5. What is coming into force? Clearing (cont.) Frontloading The obligation to clear OTC derivative contracts which are subject to the clearing obligation entered into or novated between the date of notification to ESMA and the date the clearing obligation takes effect if the OTC derivative contracts have a remaining maturity higher than the MRM (as at the date the clearing obligation applies) as determined by the EC Does not apply to NFC+s Does not apply to Category 3 counterparties If an OTC derivative contract is entered into between counterparties in different categories, the MRM is the longer of the two 50

52 5. What is coming into force? Clearing (cont.) Frontloading timeframes Category 1 Period A between the notification to ESMA and two (2) months after the entry into the RTS no contracts in Period A will be subject to the frontloading obligation Period B between two (2) months after the entry into the RTS and the date on which the clearing obligation takes effect MRM is set at six (6) months Category 2 Period A between the notification to ESMA and five (5) months after the entry into the RTS no contracts in Period A will be subject to the frontloading obligation Period B between five (5) months after the entry into the RTS and the date on which the clearing obligation takes effect MRM is set at six (6) months 51

53 5. What is coming into force? Clearing (cont.) Clearing Documentation Between CCP and CM CCP Rules Between CM and Client Master Agreement (ISDA Master or FOA Terms of Business) Client Clearing Agreement (based on industry initiatives) ISDA Master: ISDA/FOA Addendum (cleared and uncleared OTC derivatives, not ETDs) FOA Terms of Business: ISDA/FOA Addendum or FOA Clearing Module (cleared OTC and ETD, not uncleared OTC derivatives) Confirmations Collateral Agreement (Credit Support Annex) 52

54 5. What is coming into force? Clearing (cont.) Considerations with respect to Clearing Documentation Collateral Existing CSA disapplied and separate CSA is created for each CCP service Ability to port transactions Client right to transfer to replacement CM but subject to conditions CCP obligation on default of CM Events of Default Default of Client, CM or CCP Liability/Indemnity CM is a riskless principal 53

55 5. What is coming into force? Clearing (cont.) Checklist Seek to identify (based on consultation papers etc.) which traded products will be subject to mandatory clearing Identify which category relevant counterparties will fall into for clearing purposes and determine if frontloading will apply Identify which counterparties will be required to comply with clearing Identify whether any exemptions apply: - Intra group - Covered bonds Consider the clearing arrangements in place: - Clearing Member relationships - CCP relationships - Specify level of segregation (in writing) - Documentation - Margin requirements Discuss and consider which type of Client Clearing Agreement is most appropriate: - ISDA/FOA Client Cleared OTC Derivatives Addendum - FOA Clearing Module - Clearing Members own clearing documentation - CCP based initiatives Before clearing obligation comes into force RTS enters into force Ongoing Now Ongoing Ongoing 54

56 6. Expected developments Q Expected delivery of the Draft RTS to the EC in respect of OTC credit derivative classes Expected delivery of the Draft RTS to the EC in respect of margining of uncleared derivatives Possible publication of the margin RTS in the Official Journal Other third country central banks expected to be added to the list of exempted entities in Art.1(4) EMIR NCAs expected to start accepting applications for the intra group exemption to the clearing obligation Q Publication by the EC of a general report regarding EMIR implementation pursuant to Art. 85(1) EMIR by 17 August 2015 Start of two (2) year extension to exemption from clearing obligation for pension schemes Possible publication of the 1 st clearing obligation RTS in the Official Journal 55

57 6. Expected developments 2016 Possible start date for clearing obligation for Category 1 and 2 counterparties ESMA to list pension arrangements specifically exempted from the clearing obligation by the national competent authorities (before 1 st clearing obligation applies for Category 2 counterparties) Start date for implementation of margin requirements for uncleared OTC derivatives (subject to phase in requirements) 2017 Possible start date for clearing obligation for Category 3 counterparties Deadline for reporting to TRs pre existing contracts that were not outstanding on the reporting start date Possible start date for clearing obligation for Category 4 counterparties

58 Conclusion and Questions 57

59 CMS Legal Services EEIG (CMS EEIG) is a European Economic Interest Grouping that coordinates an organisation of independent law firms. CMS EEIG provides no client services. Such services are solely provided by CMS EEIG s member firms in their respective jurisdictions. CMS EEIG and each of its member firms are separate and legally distinct entities, and no such entity has any authority to bind any other. CMS EEIG and each member firm are liable only for their own acts or omissions and not those of each other. The brand name CMS and the term firm are used to refer to some or all of the member firms or their offices. CMS locations: Aberdeen, Algiers, Amsterdam, Antwerp, Barcelona, Beijing, Belgrade, Berlin, Bratislava, Bristol, Brussels, Bucharest, Budapest, Casablanca, Cologne, Dubai, Duesseldorf, Edinburgh, Frankfurt, Geneva, Glasgow, Hamburg, Istanbul, Kyiv, Leipzig, Lisbon, Ljubljana, London, Luxembourg, Lyon, Madrid, Mexico City, Milan, Moscow, Munich, Muscat, Paris, Prague, Rio de Janeiro, Rome, Sarajevo, Seville, Shanghai, Sofia, Strasbourg, Stuttgart, Tirana, Utrecht, Vienna, Warsaw, Zagreb and Zurich. 58

60 EMIR: "an overview" The European Market Infrastructure Regulation (Regulation no. 648/2012) ( EMIR ) was first proposed by the European Commission ( EC ) on 15 September 2010, and finally agreed by the European legislature on 4 July It was published in the Official Journal on 27 July, and on 16 August it legally entered into force. As a Regulation, EMIR will be directly effective in all member states without the need for any national legislation. However, under the four-stage process by which EU financial legislation is made, EMIR is only a framework, and lacks much technical detail. Instead, it requires the European Securities & Markets Authority ( ESMA ) to develop regulatory technical standards ( RTS ) on various points, and then provide them to the EC, who will implement them as directly effective secondary legislation. The deadline for ESMA to develop these is 30 September A set of draft RTS were published by ESMA on 25 June and final RTS on 27 September. The deadline set by the G20 for implementing EMIR is the end of This report comprises a short summary of the clearing obligation that is the central part of EMIR; some of the main debates over the Regulation, including amendments adopted and rejected; and a detailed breakdown of the contents of the published legislation. The Clearing Obligation EMIR implements new requirements for the clearing of OTC derivatives that were agreed by the G20 in 2009 in Pittsburgh: All standardised OTC derivatives contracts should be [ ] cleared through central counterparties by end-2012 at latest. OTC derivatives contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements. EMIR requires that some (but not all) OTC derivatives contracts must be cleared through central counterparties ( CCPs ). Contracts that are not cleared through a CCP will be made subject to increased collateral requirements and other safeguards. EMIR also includes various prudential and administrative requirements for CCPs, as well as a new reporting requirement for OTC derivatives contracts. What will the clearing obligation apply to? The classes of OTC derivative contract to which the clearing obligation shall apply will be decided either: - by ESMA, after considering the classes of contract that national regulators have authorised CCPs to clear, and deciding in some of these cases to make clearing mandatory for such contracts; or - by ESMA acting on its own initiative (subject to consultation). These are known as the bottom-up and top-down approaches, respectively.

61 Who will the clearing obligation apply to? EMIR will apply to - financial counterparties; and - non-financial counterparties i.e. everyone else who hold large positions in OTC derivatives (other than those OTC derivatives entered into for hedging purposes). There are certain exemptions for public bodies, pension funds, and intra-group transactions. Developments Scope As cited above, the impetus for EMIR was the 2009 agreement of the G20 on OTC derivatives. The working party of the Council of the European Union had at one point suggested that the clearing obligation be extended to cover all derivatives, but unsurprisingly this did not make it into the final Regulation. UCITS The European Parliament s Economic and Monetary Affairs Committee ( ECON ) had suggested a narrowlydefined derogation for UCITS that carry out only low-volume derivatives transactions, exempting them from the EMIR requirements. This was not accepted, however. Credit Default Swaps The Report of the European Economic and Social Committee ( EESC ) on EMIR described Credit Default Swaps ( CDSs ) as a potential mortal danger to the world financial system and warned the EC not to overestimate the benefits that CCPs could bring to CDS markets. Nevertheless, neither the final version of EMIR, or the draft ESMA technical standards of 25 June makes any specific provision for CDSs. SMEs/SMUs De Minimis Exemptions ECON had also suggested sector-specific clearing thresholds for small-to-medum-sized undertakings ( SMUs ), with a view to exempting some of these from the clearing obligation, as well as a de minimis rule with regard to the reporting obligation. Neither appear in the final version of EMIR: there is a single clearing threshold for nonfinancial counterparties, and all financial counterparties are automatically subject to the clearing obligation. There appear to be no exemptions from the comprehensive reporting requirement, either in EMIR itself, or in the draft regulatory technical standards on reporting prepared by ESMA. The reporting requirement will therefore apply to all counterparties (undefined in EMIR, but defined by ESMA in the draft regulatory technical standards as both financial and non-financial counterparties; i.e. all undertakings.) Reporting Obligation for Non-Financial Counterparties The original EC proposal for EMIR had required that non-financial counterparties should only report OTC derivatives transactions above a certain level an information threshold for the reporting obligation analogous to the clearing threshold for the clearing obligation. ECON proposed that, subject to the de minimis rule above, the reporting obligation for non-financial counterparties should apply to all derivatives trades, rather than just those above the information threshold. The information threshold was subsequently abandoned in the final version of EMIR. Clearing Threshold for Non-Financial Counterparties The original EC proposal had stated that non-financial counterparties would become subject to the clearing obligation immediately after exceeding the clearing threshold. ECON proposed, instead, that the obligation should only apply if the threshold had been exceeded on 90 consecutive days, and that subsequently firms should have six months in which to meet their new clearing obligations. In the final text, a 30-day rolling average is used, and a period of four months is allowed.

62 In Depth Arts. 1-3: Scope and Definitions Financial counterparties are defined as: - investment firms authorised under MiFID; - credit institutions authorised under CRD; - insurance undertakings authorised under the First Non-Life Directive; - assurance undertakings authorised under the Consolidated Life Directive; - reinsurance undertakings authorised under the Reinsurance Directive; - UCITS authorised under UCITS; - IORPS authorised under IORPS; and - Alternative Investment Funds authorised under AIFMD. All other undertakings are non-financial counterparties. Various public bodies are excluded from the clearing obligation (but not the reporting obligation), as are certain arrangements concerning pensions (see Implementation and Transitional Provisions etc. below). Art. 4: Establishing the Clearing Obligation The clearing obligation will apply to certain types of OTC derivatives contracts (as further described below) entered into: - between two financial counterparties; or - between one financial and one non-financial counterparty, where the latter has exceeded the threshold limit; or - between two non-financial counterparties, both of which have exceeded the threshold limit; or - between a financial counterparty (or non-financial counterparty over the threshold) and a third country party that would have been subject to the obligation were it based in the EU; or - between two such third country parties, provided that the contract has a direct, substantial and foreseeable effect within the EU. This is in part an anti-avoidance measure, and will be elaborated upon by ESMA in subsequent legislation. If the clearing obligation applies to a contract - because it concerns a type of OTC derivative covered by the Regulation, and because both parties fall within one of the categories above then the contract must be cleared through a CCP. In this case both counterparties must either: - become a clearing member of a CCP; - become the client of a clearing member; or - establish indirect clearing arrangements. Intragroup transactions are mostly exempt from the clearing obligation (subject to certain notification, risk management and third country provisions in Art. 3). Arts. 5-6: The Procedure for Applying the Clearing Obligation to Classes of Derivatives

63 This establishes both the top-down and bottom-up procedures for recommending derivatives for central clearing which are described above. Article 5 also provides ESMA with a set of criteria to consider when deciding whether or not to apply the clearing obligation to a given class of derivatives ( with the overarching aim of reducing systemic risk ), and requires them to produce secondary legislation elaborating on these criteria. The details as to which derivatives are subject to the clearing obligation will be kept in a register run by ESMA. Arts. 7-8: Access to CCPs for Trading Venues, and to Trading Venues for CCPs In order to avoid any market distortion caused by the new CCP clearing requirement (e.g. an unfair advantage for CCPs already linked with trading venues), EMIR includes a requirement that CCPs must accept clearing contracts from trading venues (and trading venues must provide trade feeds to CCPs) on a non-discriminatory and transparent basis. Art. 9: Establishing the Reporting Obligation Both CCPs and the counterparties themselves must report the details of any derivatives contract (including any modifications or terminations of that contract) to a trade repository as soon as possible, and no later than the next working day. In the absence of a trade repository these must be reported to ESMA. Reporting may be delegated. This reporting requirement applies to all derivatives contracts that were entered into, or remained outstanding, on or after 16 August 2012, and supersedes any contractual restrictions on disclosure of information. ESMA s regulatory technical standards will set out the precise details to be reported. Art. 10: Threshold Limit for Non-Financial Counterparties This establishes that non-financial counterparties will be subject to any clearing obligation stated to apply in respect of an OTC derivative contract if their 30-day rolling average position in such OTC derivative contracts exceeds a certain threshold. Derivatives contracts entered into for the direct purpose of hedging such counterparties commercial or treasury financing risks do not count towards the relevant threshold limit. Once the clearing obligation applies to a non-financial counterparty it has four months in which to begin clearing all future contracts. If a non-financial counterparty can demonstrate to the national regulator that its 30-day rolling average position in OTC derivatives no longer exceeds the clearing threshold, they will be thereafter excused from the clearing obligation. This article does not specify the precise threshold figure, but rather asks ESMA to establish this in regulatory technical standards. Art. 11: Additional Requirements and Safeguards for Non-CCP Cleared OTC Derivatives Financial and non-financial counterparties entering into OTC derivative contracts that aren t cleared through a CCP must exercise due diligence to ensure that: - appropriate procedures and arrangements are put into place to measure, monitor and mitigate operational and counterparty credit risk; - the terms of the relevant contract are confirmed in timely fashion, and by electronic means if possible; - processes for reconciling portfolios, managing risks, monitoring the value of contracts and identifying disputes between parties are formalised; - contracts are marked-to-market on a daily basis (where market conditions allow); - they have risk management procedures that require timely, accurate and appropriately segregated exchange of collateral; and - they hold an appropriate and proportionate amount of capital to manage the risk not covered by exchange of collateral.

64 These requirements will also apply to OTC derivative contracts between third country entities that would have been subject to the above requirement if they were based in the EU, provided that the contract has a direct, substantial and foreseeable effect within the EU, or else is necessary to prevent evasion of the Regulation. Requirements are lessened for intragroup transactions. ESMA will provide further detail for this section in subsequent legislation. Art. 12: Penalties Member states are required to institute penalties for breaching of the rules. These must include at least administrative fines, and all punishments should be made public, if possible. Infringement of the rules will not affect the validity of any contract for OTC derivatives, or allow any party to a contract the right to claim compensation from another. Art. 13: Administrative Powers for Declaring Third Country Equivalence Arts : Rules for Central Counterparties Most of EMIR is taken up with detailed rules for the authorisation and management of CCPs. Arts : Rules for Trade Repositories ESMA has extensive powers to request information from trade repositories, and to levy fines (and other punishments) on them for non-compliance. Art : Obligations on ESMA and National Regulators; Implementation and Transitional Provisions etc. The EC will review the effectiveness of EMIR by 17 August For three years after EMIR enters into force (i.e. until 16 August 2015) pension schemes entering into OTC derivatives contracts with the aim of reducing investment risks relating to the solvency of their arrangements will be exempted from the clearing obligation. The exemption will also apply to entities which provide compensation to members of pension schemes in case of default. (The additional requirements and safeguards for non-ccp cleared OTC derivatives will still apply to these contracts, however.) Contacts Ash Saluja Partner T: +44 (0) E: ash.saluja@cms-cmck.com Jason Harding Partner T: +44 (0) E: jason.harding@cms-cmck.com Will Dibble Partner T: +44 (0) E: will.dibble@cms-cmck.com Michael Cavers Partner T: +44 (0) E: michael.cavers@cms-cmck.com 1 October This report is for general purposes and guidance only and does not constitute legal or professional advice and should not be relied on or treated as a substitute for specific advice relevant to particular circumstances. For legal advice, please contact your main contact partner at the relevant CMS member firm. If you are not a client of a CMS member firm, or if you have general queries about Law-Now or RegZone, please send an to: law-now.support@cmslegal.com so that your enquiry can be passed on to the right person(s). All Law-Now and RegZone information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

65 CMS Legal Services EEIG (CMS EEIG), has its head office at: Barckhausstraße 12-16, Frankfurt, Germany. The contact address for CMS EEIG is its Ust-ID is: DE and it is registered on Handelsregister A in Frankfurt am Main with the registration number: HRA CMS Legal Services EEIG (CMS EEIG) is a European Economic Interest Grouping that coordinates an organisation of independent law firms. CMS EEIG provides no client services. Such services are solely provided by CMS EEIG s member firms in their respective jurisdictions. CMS EEIG and each of its member firms are separate and legally distinct entities, and no such entity has any authority to bind any other. CMS EEIG and each member firm are liable only for their own acts or omissions and not those of each other. The brand name CMS and the term firm are used to refer to some or all of the member firms or their offices. CMS EEIG member firms are: CMS Adonnino Ascoli & Cavasola Scamoni, Associazione Professionale (Italy); CMS Albiñana & Suárez de Lezo S. L. P. (Spain); CMS Bureau Francis Lefebvre S. E. L. A. F. A. (France); CMS Cameron McKenna LLP (UK); CMS China (China); CMS DeBacker SCRL / CVBA (Belgium); CMS Derks Star Busmann N. V. (The Netherlands); CMS von Erlach Poncet Ltd (Switzerland); CMS Hasche Sigle Partnerschaft von Rechtsanwälten und Steuerberatern mbb (Germany); CMS Reich-Rohrwig Hainz Rechtsanwälte GmbH (Austria); CMS Russia and CMS Rui Pena, Arnaut & Associados RL (Portugal). For more information about CMS including details of all of the locations in which CMS operates please visit: CMS Legal All rights reserved.

66 EMIR: the Proposed European Regulation on Derivatives, Central Counterparties and Trade Repositories On 15 September 2010 the European Commission published its Proposal for a Regulation of the European Parliament and of the Council on derivatives, central counterparties and trade repositories in the EU (subject to subsequent compromise drafts, the Proposal ), otherwise known as the European Market Infrastructure Regulation ( EMIR ). The main purpose of the Proposal was to implement the mandatory clearing of certain standardised OTC (i.e. over-thecounter) derivatives transactions, that meet predefined eligibility criteria, through central counterparties ( CCPs ) and the reporting of those transactions to trade repositories, for use by relevant authorities. However, subsequent drafts of the Regulation use a wider definition of derivatives, bringing transactions executed on regulated markets into scope. This means the reporting requirements of the Regulation may apply to all types of derivatives, not just OTC transactions, and ESMA could potentially require any type of derivatives contract to be centrally cleared. The Proposal is similar in scope to the OTC derivatives legislation that has recently been adopted in the United States (i.e. the Dodd-Frank Act) and has been drafted in line with the initiative agreed by the G-20 in September 2009 that: All standardised OTC derivatives contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest. OTC derivative contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements. The Proposal sets out requirements for both financial counterparties and, in certain circumstances, nonfinancial counterparties, with respect to the clearing and reporting of derivatives contracts as well as setting out requirements for CCPs and trade repositories. Certain entities, such as central banks, national bodies performing similar functions and multilateral development banks, are specifically excluded from the scope of the Proposal. The Proposal also sets out the obligations in relation to these matters of the new European Supervisory Authority, the European Securities and Markets Authority ( ESMA ). ESMA will have responsibility for, amongst other things, determining which types of derivatives transactions should be cleared, the supervision of trade repositories and liaising with the relevant national competent authorities with respect to the authorisation of CCPs. Clearing and Reporting Requirements Financial counterparties and non-financial counterparties All financial counterparties will be subject to the clearing requirements set out in the Proposal. The definition of financial counterparty in the Proposal covers investment firms, insurance undertakings, assurance undertakings, reinsurance undertakings, undertakings for collective investments in transferable securities (UCITS), institutions for occupational retirement provision and alternative investment fund managers. Non-financial counterparties, which are defined as undertakings established in the EU that do not fall within any classification of financial counterparties, will only be subject to the clearing requirement if they exceed a clearing threshold. The level of these thresholds is not set out in the Proposal. Instead, the Proposal delegates powers to the EU Commission to specify these thresholds, which will be based on draft regulatory standards to be drawn up by ESMA by 30 June 2012, after consultation with relevant authorities.

67 According to the Proposal, the threshold recommended by ESMA will take into account systemic relevance of net positions and exposures and will be reviewed periodically. Importantly, under the latest draft, hedging transactions will not count toward the calculation of a non-financial counterparty s positions for the purpose of the threshold, but they will need to be cleared if the threshold is reached. The rationale for these thresholds is that certain non-financial counterparties are active market participants and enter into a large number of derivatives transactions and, therefore, excluding them entirely from the clearing and reporting obligations could well undermine the effectiveness of these obligations. Clearing Obligation The Proposal sets out the following two approaches that will be used to determine which type of derivatives transactions must be cleared: 1. The bottom-up approach Under this approach, a CCP will start clearing a certain type of derivatives transaction after being authorised to do so by its national competent authority. Once this authorisation has been given, such national competent authority is obliged to inform ESMA who will then decide whether aclearing obligation should apply with respect to all such derivatives transactions across the EU. Under the Proposal, ESMA has six months to make a decision and will base such a decision on certain criteria such as the reduction of systemic risk in the financial system and the liquidity of contracts. 2. The top down approach In addition, ESMA may take the initiative and decide whether a particular class of derivatives transactions should be subject to a mandatory clearing obligation. ESMA will notify the EU Commission of any such derivatives transactions. ESMA shall keep an up to date register of all eligible types of derivatives transactions that are required to be cleared and the CCPs that are authorised to clear them. Reporting Obligation Whether or not they are subject to the clearing obligation, all counterparties, whether financial or non-financial, and CCPs will be required to report the conclusion, modification and termination of every transaction of a certain type to a trade repository by the working day following the execution, clearing or modification of each such transaction. It is not yet clear whether this requirement will relate only to OTC derivatives transactions or all derivatives, as defined in the Proposal. CCPs Authorisation The competent authorities of Member States will continue to authorise (and withdraw the authorisation) for CCPs to clear particular types of derivatives transactions. In order to facilitate, amongst other things, the CCP authorisation process, the relevant competent authority will establish and chair a college consisting of other relevant competent authorities, relevant central banks and ESMA. The college will have a number of responsibilities such as providing a joint opinion about the CCP, the coordination of supervisory examination programmes based on a risk assessment of the CCP and the determination of procedures and contingency plans to address emergency situations. ESMA will, therefore, be able to play a central role in the authorisation of CCPs by ensuring that the provisions in the Proposal for the authorisation of CCPs are consistency applied. Organisational, Conduct of Business and Prudential Requirements The Proposal sets out a number of organisational, conduct of business and prudential requirements for CCPs. Although such requirements exist at a national level, they differ between different Member States and so the Proposal seeks to harmonise such requirements across Member States. The Proposal sets out various requirements for CCPs, such as having robust corporate governance arrangements and that these are publicly disclosed, along with its prices and fees. In addition, the Proposal sets out requirements relating to business continuity, segregation of assets and positions, default funds, default procedures and transaction portability between clearing members. The clearing process will entail a CCP becoming a counterparty to each derivatives transaction that it clears. Given that the main aim of the Proposal is the reduction of counterparty risk, it is important that CCPs do not fail. To that end, the various organisational, conduct of business and prudential requirements for CCPs have been included in the Proposal in order to try and avoid any such failure.

68 Portability and Segregation CCPs will only deal directly with clearing members, who will likely be major broker dealers. Other market participants will, therefore, be required to clear derivatives transactions through chosen clearing members who will, in turn, arrange for such derivatives transactions to be cleared through the relevant CCP. The Proposal requires that CCPs segregate the assets and positions of each clearing member from both the assets and positions of other clearing members and the assets and positions of the CCP. Following a pre-defined trigger event, such as the insolvency of a clearing member, a CCP will, at the request of a client, transfer the assets and positions of such clearing member to another clearing member. The alternative clearing member will only be obliged to accept such assets and positions where it has previously agreed to do so pursuant to a contractual relationship for that purpose. Therefore, clients of a clearing member that is subject to such a pre-defined trigger event will be able to move or port their assets and positions to another clearing member. It is anticipated that this will provide a certain degree of market stability following the collapse of a major broker dealer and isolate market participants from counterparty risk as much as possible. Trade Repositories Trade Repositories will be responsible for holding information on derivatives that is provided by counterparties and CCPs pursuant to the reporting obligation described above. In contrast to the authorisation of CCPs, the Proposal gives ESMA powers to register (and remove the registration) of trade repositories. Given the central role played by trade repositories and their lack of fiscal responsibility the Commission is of the view that ESMA will be in a better position to carry out these functions than a relevant national authority. ESMA will also be responsible for ensuring that each trade repository is meeting the various requirements for trade repositories set out in the Proposal. Trade repositories, like CCPs, will be required to ensure that they have robust corporate governance arrangements in place. In addition, trade repositories will be required to, amongst other things, ensure that the regulatory information that they hold on derivatives transactions is reliable and secure. Consideration and Implementation The Proposal is still being considered by the Council of the EU, with political agreement expected by mid-may It is anticipated that the European Parliament will adopt the Proposal shortly afterwards, with ESMA to provide the technical standards that are to apply by 30 June 2012 and for the Regulation to apply by the end of It is important to note that the legislation will be a Regulation, not a Directive. This means that its provisions will have direct effect and will not be subject to legislative interpretation at the national level. The Commission chose a Regulation because it achieves a greater level of harmonisation than a Directive. Contacts Ash Saluja Partner T: +44 (0) E: ash.saluja@cms-cmck.com Jason Harding Partner T: +44 (0) E: jason.harding@cms-cmck.com Will Dibble Partner T: +44 (0) E: will.dibble@cms-cmck.com Michael Cavers Partner T: +44 (0) E: michael.cavers@cms-cmck.com 27 September 2012 This report is for general purposes and guidance only and does not constitute legal or professional advice and should not be relied on or treated as a substitute for specific advice relevant to particular circumstances. For legal advice, please contact your main contact partner at the relevant CMS member firm. If you are not a client of a CMS member firm, or if you have general queries about Law-Now or RegZone, please send an to: law-now.support@cmslegal.com so that your enquiry can be passed on to the right person(s).

69 All Law-Now and RegZone information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments. CMS Legal Services EEIG (CMS EEIG), has its head office at: Barckhausstraße 12-16, Frankfurt, Germany. The contact address for CMS EEIG is its Ust-ID is: DE and it is registered on Handelsregister A in Frankfurt am Main with the registration number: HRA CMS Legal Services EEIG (CMS EEIG) is a European Economic Interest Grouping that coordinates an organisation of independent law firms. CMS EEIG provides no client services. Such services are solely provided by CMS EEIG s member firms in their respective jurisdictions. CMS EEIG and each of its member firms are separate and legally distinct entities, and no such entity has any authority to bind any other. CMS EEIG and each member firm are liable only for their own acts or omissions and not those of each other. The brand name CMS and the term firm are used to refer to some or all of the member firms or their offices. CMS EEIG member firms are: CMS Adonnino Ascoli & Cavasola Scamoni, Associazione Professionale (Italy); CMS Albiñana & Suárez de Lezo S. L. P. (Spain); CMS Bureau Francis Lefebvre S. E. L. A. F. A. (France); CMS Cameron McKenna LLP (UK); CMS China (China); CMS DeBacker SCRL / CVBA (Belgium); CMS Derks Star Busmann N. V. (The Netherlands); CMS von Erlach Poncet Ltd (Switzerland); CMS Hasche Sigle Partnerschaft von Rechtsanwälten und Steuerberatern mbb (Germany); CMS Reich-Rohrwig Hainz Rechtsanwälte GmbH (Austria); CMS Russia and CMS Rui Pena, Arnaut & Associados RL (Portugal). For more information about CMS including details of all of the locations in which CMS operates please visit: CMS Legal All rights reserved.

70 EMIR: the Final Adopted Regulatory Technical Standards Update The European Market Infrastructure Regulation (Regulation no. 648/2012) ( EMIR ) legally entered into force on 16 August 2012, but its implementation in practice depends on secondary legislation prepared by the European Securities & Markets Authority ( ESMA ). ESMA published a discussion paper on 16 February 2012, followed by a set of draft implementing technical standards ( ITS ) and regulatory technical standards ( RTS ) on 25 June. The final version of the RTS and ITS were published on 27 September, and adopted 1 by the European Commission ( EC ) without modification on 19 December They are due to come into force around mid-march (Please see The Future, below, for implementation details.) What follows is a summary of those technical standards included in the adopted RTS and ITS which may be relevant for parties entering into OTC derivative transactions. ESMA was also required to prepare RTS and ITS on the specific requirements for CCPs and Trade Repositories ( TRs ), which are not discussed in this note except where relevant. Regulatory Technical Standards provided by ESMA 1. RTS specifying which indirect clearing arrangements offer equivalent levels of protection to either (i) being a clearing member oneself or (ii) being a client of a clearing member, and as such would be acceptable methods of discharging the clearing obligation. (Art. 4(4) EMIR.) ESMA s original draft RTS of 25 June relating to indirect clearing arrangements received a very large volume of responses, highlighting that the proposals for indirect clearing were unworkable both practically and legally. The original draft was therefore substantially revised. The final RTS defines an indirect clearing arrangement as a set of contractual arrangements which allows the client of a clearing member to provide clearing services to a client of a client of a clearing member, i.e. its own clients. Rather than adopt a prescriptive approach, ESMA has set out a broad framework intended to ensure that indirect clients can obtain an equivalent level of protection as direct clients in a default scenario. It remains unclear how as a practical matter indirect clearing will work, in the absence of further legislative change (particularly in relation to national insolvency regimes). ESMA will monitor the development of indirect clearing arrangements. The rules for parties to an indirect clearing arrangement are set out in Articles 1-4 of the final RTS and are broadly as follows: - CCPs must: not adopt business practices that would act as a barrier to clients establishing indirect clearing arrangements on reasonable commercial terms; identify, monitor and manage certain risks that might arise from indirect clearing arrangements; 1 With one exception, concerning colleges of central counterparties. This aspect of EMIR is not dealt with in this document, however. The EC has stated that the rejection of this one RTS will not affect the implementation of the clearing requirement.

71 if a clearing member so requests, maintain separate records and accounts for the clearing member s clients and their clients clients (i.e. the indirect clients) in a manner that satisfies Art. 39(9) EMIR 2 ;and provide certain support to a clearing member in relation to the default of a client providing indirect clearing services. - Clearing members have no obligation to facilitate indirect clearing arrangements. If a clearing member elects to facilitate indirect clearing arrangements: such indirect clearing arrangements must be on reasonable commercial terms; the clearing member must publicly disclose the general terms of the contractual arrangements (but without prejudice to the confidentiality of such arrangements); the clearing member must maintain separate records and accounts enabling a client to distinguish either (i) the assets and positions of the client from those held for the accounts of its indirect clients or (ii) the assets and positions of held for the account of an indirect client from those held for the account of other indirect clients, as instructed by its client, in a manner that satisfies Art. 39(9) EMIR; the clearing member will be obliged to identify, monitor and manage any risks that might arise from facilitating indirect clearing arrangements; the clearing member must establish robust procedures to cope with the default of a client that provided indirect clearing services, including (i) a credible mechanism for transferring the positions and assets to an alternative client or clearing member (subject to the agreement of the relevant indirect clients) and (ii) a mechanism for the prompt liquidation of indirect clients assets and positions; and the clearing member must have a robust internal procedure to safeguard any information provided to it by a client for the purposes of managing risk. - The client of a clearing member that wishes to offer indirect clearing to its clients must: be an authorised credit institution or investment firm (or a third-country equivalent); consult with the clearing member on the aspects that may impact the operations of the clearing member; include an obligation on the client, in the agreement between the client and the indirect client, to honour all obligations of the indirect client towards the clearing member (that arise from the indirect clearing arrangement); keep separate records and accounts for themselves and for the indirect clients in a manner that satisfies Art. 39(9) EMIR; offer the indirect clients a choice of segregation options and keep the indirect clients fully informed of the risks thereof; ask the clearing member to open a segregated account at the CCP for holding the assets and positions of its indirect clients; and provide information to the clearing member that allows the clearing member to identify, monitor and manage any risks arising as a result of facilitating indirect clearing. The client will not be required to disclose information on individual indirect clients, except for the purposes of managing risk (see above) or in the event that the client defaults, in which case the client must immediately pass all the information in respect of the indirect clients to the clearing member. 2 i.e. where (a) the assets and positions are recorded in separate accounts; (b) the netting of positions recorded on different accounts is prevented; and (c) the assets covering the positions recorded in an account are not exposed to losses connected to positions recorded in another account.

72 2. RTS specifying the details that competent authorities (e.g. national regulators) should send to ESMA when applying to make a class of OTC derivatives subject to the mandatory clearing obligation under the bottom-up approach (Art. 5 EMIR.) The bottom-up approach to applying the clearing obligation is where a CCP decides to begin clearing a new class of OTC derivative transaction and applies to its national regulator for authorisation to do so. If the national regulator grants such authorisation, it shall also inform ESMA; and ESMA will then decide whether all such transactions must be subject to a mandatory clearing obligation. Although Article 5 EMIR anticipates that the national regulator will supply ESMA with information on which to make a decision, in practice ESMA have moved the burden for obtaining the information on to the CCPs. CCPs will have to supply to the national regulators (who will then pass on to ESMA) the following: - the identification of the class of OTC derivatives, and the type of transactions within the class; - other information about the transactions that ESMA will need to include in the public register, such as the asset - class, the underlying(s), the notional and settlement currencies, settlement conditions, range of maturities, range of - payment frequency, and the product identifier; - any other information needed in order to distinguish the type of transactions affected; - evidence of standardisation, including data on the daily reference price; - volume data, including the number of transactions, total volume, total open interest, depth of orders, average number of orders and requests for quotes, and tightness of spread; - liquidity data, including measures of liquidity under stressed market conditions and for the executive of default procedures; - evidence of the availability of reliable pricing information; - evidence of the ability of CCPs to handle the expected volume of transactions, and to manage the risk arising from them; - details of what tasks would be done in order to prepare for clearing these transactions, with estimates of the time involved; and - evidence of the potential impact of the clearing obligation on: the availability of reliable pricing information; the expected volume of OTC derivatives transactions in that class; the type and number of counterparties active in the market for that type of transaction; and the effect on the risk management, legal and operational capacity of the counterparties active. This information will be published by ESMA in the public register (which is intended to put market participants in a position to prepare for compliance with a potential clearing obligation). The recitals to the final RTS acknowledge that, for new derivatives products, specific historical data might not always be available. 3. RTS specifying the criteria that ESMA will assess when deciding whether or not to extend the clearing obligation to a new class of OTC derivatives in order to reduce systemic risk (Art. 5(4) EMIR.) The criteria set out in EMIR as developed by ESMA, are as follows. ESMA must take into consideration: - The degree of standardisation of contractual terms (Art. 5(4)(a) EMIR), including the incorporation of common legal documents such as master netting agreements, the use of standard terms, definitions, and confirmations which set out specifications commonly used by counterparties (Art. 6(1)(a) of the final RTS).

73 - The degree of standardisation of operational processes (Art. 5(4)(a) EMIR), including whether they are subject to automated post-trade processing and lifecycle events managed in a common manner and to a widely-agreed timetable (Art. 6(1)(b) of the final RTS). - The volume and liquidity of the relevant class of derivatives (Art. 5(4)(a) EMIR), including whether or not the margins or financial requirements of the CCP are proportionate to the risks, the stability and market size and depth of the class, the effect of clearing member default on market dispersion, and the number and value of transactions (Art. 6(2)(a)-(d) of the final RTS). - The availability of reliable pricing information (Art. 5(4)(c) EMIR), including whether or not this information is easily accessible to market participants on a reasonable commercial basis, and whether this would be affected by the clearing obligation (Art. 6(3) in the final RTS). 4. RTS specifying the notion of liquidity fragmentation (Art. 8(5) EMIR.) Art. 8 EMIR provides that a trading venue is required to provide trade feeds on a non-discriminatory basis to any CCP that requests them and which is authorised to clear the relevant class of OTC derivatives. This access is subject to the condition that it does not threaten the smooth and orderly functioning of markets in particular due to liquidity fragmentation. Liquidity fragmentation occurs where parties on a trading venue are unable to conclude a transaction because they do not all have access to the same clearing arrangements. To avoid this situation, Art. 8 of the final RTS provides that before a new CCP can join a trading venue, they must put in place safeguards to make sure that everyone on the trading venue has access to at least one CCP in common (possibly through indirect clearing arrangements) or some other arrangement established by the CCPs, such as transferring transactions to the clearing members of other CCPs. However the draft final RTS makes clear that clearing members of the original CCP should not be forced to become clearing members of the new CCP in order to complete a transaction. 5. RTS specifying the details of OTC derivatives transactions that counterparties need report to TRs, as well as the format, frequency, etc., of such reports (Art. 9(5)-(6) EMIR.) The following data must be supplied by each of the counterparties (or their delegates) separately: 1. Date and time of the reporting 2. Reporting counterparty s unique ID code 3. Other counterparty s unique ID code 4. Name of counterparty 5. Full address of counterparty 6. Corporate sector of counterparty (e.g. bank, insurance company, etc.) 7. Is it a financial or non-financial counterparty (according to EMIR)? 8. Counterparty s broker s unique ID code (if applicable) 9. Reporting entity s ID 10. Clearing member s ID 11. Beneficiary s unique ID (if the counterparty is not the beneficiary to the contract) 12. Whether contract was executed on counterparty s own account or for the account of/on behalf of a client. 13. Whether the reporting counterparty was buying or selling 14. Whether the counterparty was trading with a non-eea counterparty 15. (For non-financial counterparties) was the contract directly linked to commercial or treasury financing activity (c.f. the EMIR clearing threshold)? 16. (For non-financial counterparties) is the counterparty above the EMIR clearing threshold? 17. Mark-to-market value of the contract 18. Currency of mark-to-market valuation 19. Valuation date 20. Valuation time 21. Valuation type, e.g. mark-tomarket or mark-to-model 22. Whether or not the contract is collateralised 23. (If collateralised) whether there is a collateral portfolio 24. (If collateral portfolio) collateral portfolio code 25. (If collateralised) value of the collateral 26. (If collateralised) currency of the collateral valuation The following data can be supplied by just one of the counterparties (or their delegate). The list below is taken from the final RTS, but incorporates some of the notes from the 25 June draft RTS where applicable: 1. Taxonomy of the reported contract Unique product ID. 4. Unique ID for any underlying instruments (including baskets or indices) Notional currency 7. Deliverable currency 8. Internationally agreed trade ID 9. Transaction reference number. 10. Unique ID of trading venue (or note that it was concluded OTC) 26. Date and time of confirmation 27. Whether contract was electronically confirmed/nonelectronically confirmed/unconfirmed 28. Whether reported contract is subject to the clearing obligation. 29. Whether clearing has taken place. 30. (If cleared) Time and date of clearing 31. (If cleared) CCP s unique ID 45. (For commodity derivatives) name of the commodity base, e.g. agriculture or metals. 46. (For commodity derivatives) details of the particular commodity, e.g. livestock or oil 47. (For commodity derivatives) delivery point or zone: physical or virtual point where the delivery takes place 48. (For commodity derivatives) interconnection point

74 11. Does the contract result from compression? 12. Price/rate per derivative. 13. Price notation 14. Notional amount: face value of the contract, value of the deliverables 15. Price multiplier: no. of derivatives represented by one contract. 16. Quantity: no. of contracts included in the contract 17. Amount of any up-front payment 18. Delivery type: whether the contract is settled physically or In cash 19. Time and date the contract was executed or modified 20. Date when obligations under the contract come into effect 21. Maturity date: date when contract expires/exercise date. 22. Termination date (if different from maturity date) 23. Date of settlement of the underlying 24. Master agreement type (if applicable). 25. Master agreement version date (if applicable) code. 32. Whether contract part of an intra-group transaction (For interest rate derivatives) level of the fixed rate leg 35. (For interest rate derivatives) fixed rate day count fraction: actual number of days in the relevant fixed rate payer calculation period. 36. (For interest rate derivatives) frequency of payments for the fixed rate leg 37. (For interest rate derivatives) frequency of payments for the floating rate leg 38. (For interest rate derivatives) frequency of floating rate leg resets (For interest rate derivatives) name of floating rate index 41. (For currency derivatives) the cross currency, as different from the currency of delivery (#4). 42. (For currency derivatives) exchange rate 1, at the moment of the conclusion of the contract 43. (For currency derivatives) forward exchange rate, at the moment of the conclusion of the contract 44. (For currency derivatives) exchange rate basis; e.g. EUR/USD or USD/EUR 49. (For commodity derivatives) load type: product delivery profile: baseload, peak, off-peak, block hours or other 50. (For commodity derivatives) delivery start date and time 51.(For commodity derivatives) delivery end date and time 52.(For commodity derivatives) contract capacity 53.(For commodity derivatives) quantity unit 54.(For commodity derivatives) price/time interval quantities 55. (For options contracts) whether the option is a put or a call (from the counterparty s perspective) 56. (For options contracts) whether the option can be exercised only on a fixed date, or at any time in the life of a contract; i.e. American, Bermudan, European or Asian style. 57. (For options contracts) strike price of the option 58. Whether the report is new, modifying details of a previouslyreported contract, cancelling a trade, or making some other amendment 59. Details of the action type. In the accompanying consultation paper, ESMA hinted that, in spite of calls to harmonise reporting requirements under REMIT, MiFID and EMIR (so that parties would only need to send one set of reports to a joint EMIR Trade Repository/MiFID Approved Reporting Mechanism in order to discharge all their regulatory reporting obligations), this might not happen any time soon (although ESMA will continue working towards the objectives ). 6. RTS setting the criteria for applying the clearing threshold exemption for OTC derivative transactions held by non-financial parties for the purposes of hedging (etc.) alone (Art. 10(4)(a) EMIR.) An OTC derivative transaction will fall into the Art. 10(3) EMIR exemption (and so will not be taken into account for the purposes of determining whether the clearing threshold in relation to a non-financial counterparty has been exceeded) if: - it covers the risks arising from: the potential change in the value of assets, services, inputs, products, commodities or liabilities that the non-financial counterparty or its group owns, produces, manufactures, processes, provides, purchases, leases, sells or incurs or reasonably anticipates owning, producing, manufacturing, processing, providing, purchasing, merchandising, leasing, selling or incurring in the normal course of its business; or the potential indirect impact on the value of assets, services, inputs, products, commodities or liabilities referred to in subparagraph (a), resulting from fluctuation of interest rates, inflation rates, foreign exchange rates or credit risk; or - it qualifies as a hedging transaction under the International Financial Reporting Standards. An OTC derivatives transaction can meet the conditions above either by itself or in combination with other OTC derivatives transactions. Proxy hedging, portfolio hedging and offsetting hedges are all permitted, as long as they meet the criteria above. In addition, OTC derivative transactions connected with hedging employee benefits (such as stock options), company credit risk, and the acquisition of other companies, will all fall within the criteria.

75 7. RTS setting the values of the clearing threshold (Art. 10(4)(b) EMIR.) The clearing thresholds in Article 10 of the final RTS are: Type of OTC derivatives transaction Credit derivatives Equity derivatives Interest rate derivatives Foreign exchange derivatives Commodity derivatives and other OTC derivative transactions Gross notional value 1bn 1bn 3bn 3bn 3bn When a non-financial counterparty reaches the clearing threshold for one of the asset classes above, it is considered to have exceeded the clearing threshold. In this case, the non-financial counterparty is subject to the clearing obligation for all classes of OTC derivatives transactions (that are themselves subject to the clearing obligation), and not just the class for which they exceeded the clearing threshold. ESMA considered that using the notional value of an OTC derivatives transaction (rather than the mark-to-market) was simpler for counterparties to monitor and calculate. The clearing thresholds will be reviewed by ESMA on a regular basis. 8. RTS specifying the procedures and arrangements that counterparties must introduce to measure, monitor and mitigate risk when entering into non-centrally cleared OTC derivatives transactions (Art. 11(14)(a) EMIR.) Art. 11(1) EMIR provides that the risk management procedures for non-cleared OTC derivatives must include, at the very least, arrangements for timely confirmation, portfolio reconciliation, dispute resolution, and for monitoring the value of the outstanding transactions. Please see the section below for details on valuation. - Timely confirmation: all OTC derivatives transactions not cleared by a CCP must be confirmed as soon as possible, although the absolute final deadlines for confirmation differ depending on the circumstances: Counterparties Derivatives Deadline for confirmation Concluded between financial counterparties, or nonfinancial counterparties over the clearing threshold As above Concluded with a financial counterparty under the clearing threshold Credit default swaps ( CDS ) and interest rate swaps ( IRS ) All OTC derivatives transactions other than CDS and IRS CDS and IRS (Until 28 Feb 2014) by the end of the second business day following execution; (From 28 Feb 2014) by the end of the next business day following execution. (Until 31 Aug 2013) by the end of the third business day following execution; (From 31 Aug 2013 until 31 August 2014) by the end of the second business day following execution; (From 31 August 2014) by the end of the business day following execution. (Until 31 Aug 2013) by the end of the fifth business day following execution; (From 31 Aug 2013 to 31 Aug 2014) by the end of the third business day following execution;

76 As above All OTC derivatives transactions other than CDS and IRS (From 31 Aug 2014) by the end of the second business day following execution. (Until 31 Aug 2013) by the end of the seventh business day following execution; (From 31 Aug 2013 to 31 Aug 2014) by the end of the fourth business day following execution; (From 31 Aug 2014) by the end of the second business day following execution. Where an OTC derivatives transaction is concluded after 4pm local time, or with a counterparty in a different time zone which does not allow confirmation by the set deadline, each of the above deadlines are extended by one additional business day. Confirmation must be made electronically, and where possible and may be delegated. Financial counterparties must introduce procedures for reporting to a competent authority every month the number of OTC derivatives transactions which remain unconfirmed for more than five business days following the relevant trade date. - Portfolio reconciliation: both counterparties must agree in writing on the terms for reconciling portfolios before entering an OTC derivatives transaction. The reconciliation must cover the key trade terms that identify each individual transaction, and must include at least the daily mark-to-market valuation of the OTC derivatives transaction (subject to the exception below for circumstances permitting mark-to-model valuation). The frequency with which counterparties must perform portfolio reconciliation depends on the number of outstanding OTC derivatives transactions there are between them: Counterparties Number of outstanding OTC derivatives transactions When they must reconcile Financial counterparty, or non-financial counterparty over the clearing threshold 500 or more: each business day As above 51 to 499: once a week As above Less than 50: once every three months Non-financial counterparty under the clearing threshold 101 or more: once every three months As above 100 or less: once per year Counterparties with 500 or more OTC derivatives transactions outstanding which are not centrally cleared should conduct a portfolio compression exercise at least twice a year, in order to reduce counterparty credit risk. Alternatively, they should at least analyse the possibility of doing so, and be able provide a reasonable explanation of why a portfolio compression exercise was not appropriate. - Dispute resolution: counterparties must agree on a procedure for recording the details (parties, amount, length) of disputes relating to recognition or valuation of the OTC derivatives transaction or the exchange of collateral. They must also have procedures for resolving disputes in a timely manner, including specific processes for disputes not resolved within five days.

77 Financial counterparties must report to their competent authority any dispute relating to an OTC derivatives transaction, its valuation or the exchange of collateral for an amount or a value higher than EUR15,000,000 that is outstanding for at least 15 business days. 9. RTS specifying the market conditions in which marking-to-model should be used instead of marking-to-market the value of non-centrally cleared OTC derivatives (Art. 11(14)(b) EMIR.). Where the market is inactive (i.e. when quoted prices are not readily available, and the prices that are available do not represent actual, regular, arms-length transactions) then mark-to-model valuation shall be used instead of mark-to-market. Marking-to-model shall also be used where there are a significant range of estimates for reasonable fair value, and the probabilities of the various estimates cannot reasonably be assessed. ESMA have developed various criteria that any marking-to-model must fulfil. It must: - incorporate all the factors that counterparties would consider in setting a price, using as much mark-tomarket information as possible; - be consistent with accepted economic methodologies; - be calibrated against any current market activity; - be independently monitored and validated; and - be documented and approved by the board at least annually (though this may be delegated to a committee). 10. RTS specifying the information that parties must pass on to the national regulators when relying on the exemption for intragroup transactions, and what information they should publicly disclose (Art. 11(14)(c)-(d) EMIR.). By way of reminder, Art. 11(5) EMIR exempts intragroup OTC derivatives transactions where both counterparties are based in the same member state, from the requirement that both financial counterparties and non-financial counterparties over the clearing threshold, that conduct transactions in non-centrally cleared OTC derivatives transactions, shall have risk management procedures that require the timely, accurate and appropriately segregated exchange of collateral for such transactions. In respect of intragroup OTC derivatives transactions where both counterparties are not based in the same member state, in order to rely on a total or partial exemption from such requirement, the parties will either need to apply to the national regulator(s) in advance of entering into the relevant transaction, or else notify them after entering into the relevant transaction, depending on the type and location of the counterparties: Counterparty 1 Counterparty 2 Apply before or notify after? Financial counterparty Non-financial counterparty Financial counterparty Non-financial counterparty Financial counterparty Financial counterparty in different Member State Non-financial counterparty in different Member State counterparty in third country jurisdiction counterparty in third country jurisdiction Non-financial counterparty in different Member State Apply to both states national regulators beforehand Notify both states national regulators afterwards Apply to CP 1 s national regulator beforehand Notify CP 1 s national regulator beforehand Apply to the Financial CP s national regulator beforehand Whether a party is applying beforehand or notifying after entering into the relevant OTC derivatives transaction, it must notify their national regulator in writing, and provide the following information:

78 - The legal counterparties; - Unique identifier codes; - Corporate relationship; - Contractual relationship; - Category of intragroup relationships in Art. 3(1)-(2) EMIR they fall under: a contract with another member of the same group included in the same consolidation on a full basis, subject to risk evaluation etc., and established in the Union or in a recognised, equivalent third country; a contract between a financial counterparty and another financial counterparty, financial holding company, financial institution or ancillary services undertaking subject to prudential requirements, which is part of the same institutional protection scheme 3 ; or a contract between two credit institutions affiliated to the same central body, or between a credit institution and the central body 4, - Details of the OTC derivatives transaction for which they are seeking an exemption, including: - the asset class of OTC derivative contracts; - the type of OTC derivative contracts; - the type of underlyings; - the notional and settlement currencies; - the range of contract tenors; - the settlement types; - the anticipated sizes, volumes and frequency of OTC derivative contracts per annum; and - evidence of adequately sound risk management and a lack of practical or legal impediments. As part of its application or notification to the relevant competent authority, a counterparty must also submit supporting information evidencing that: - its risk-management procedures are adequately sound, robust and consistent with the level of complexity of the transaction; and - there is no current or foreseen practical or legal impediment to the prompt transfer of own funds or repayment of liabilities between the counterparties. The supporting documents shall 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. When a counterparty applies for an intra-group exemption it must also publicly disclose the following information (to ensure transparency vis-à-vis market participants and potential creditors): - the legal counterparties; - their unique identifier codes; - their corporate relationship; - whether they have been granted a full or partial exemption; and 3 c.f. Article 80(8) of the recast Banking Directive, 2006/48/EC. 4 c.f. Article 3(1) of the recast Banking Directive, 2006/48/EC.

79 - the notional aggregate amount of the OTC derivative transactions for which the intragroup exemption applies. Other RTS Although due by 30 September 2012, ESMA did not have time to prepare RTS specifying: 1) which contracts between third country entities are considered to have a direct, substantial and foreseeable effect within the EU (or are otherwise necessary to regulate in order to prevent evasion) and, as such, should be subject to EMIR. (Art. 4(4) EMIR); 2) the risk management procedures (including collateral segregation) required for transactions in noncentrally cleared OTC derivatives by financial counterparties (and non-financial counterparties over the clearing threshold) (Art. 11(15)(a) EMIR) 5 ; 3) the capital requirements for financial counterparties dealing in non-centrally cleared OTC derivatives (Art. 11(15)(b) EMIR) ** ; 4) the procedures for applying for the Art. 11 EMIR intragroup exemption (Art. 11(15)(c) EMIR) ** ; or 5) the criteria that the national regulators should use in deciding whether to grant an application for the exemption (Art. 11(15)(c) EMIR) ** ; and are waiting on the EC to assign them a new deadline for these. According to the EMIR FAQ published by ESMA on 19 November 2012, RTS (1) above is still under review ; while RTS (2) and (3) have been delayed because further international coordination is necessary on this topic before EU rules can be developed. Nothing further has been published at the time of writing. The Future As noted in the introduction ( Update ), the RTS and ITS were adopted by the EC without modification 6 on 19 December The ITS are not subject to a right of scrutiny, and so were published in the Official Journal on 21 December, taking legal effect on 10 January The ITS only contain technical provisions that complement the RTS, however, and so nothing will actually happen on this date, in practice. The RTS were sent to the European Parliament and Council of the European Union for legislative scrutiny. This is typically for a period of one month, but as was just before the Christmas holidays, the EP applied for a one-month extension to 19 February In January 2013 there were news reports that the European Parliament was considering rejecting the ESMA RTS, on the grounds that the clearing threshold for non-financial counterparties was set too low, and that it was wrong for the calculation to make no distinction between different classes of OTC derivatives contract. There were also possibly broader concerns with the volumetric approach to imposing the clearing obligation on non-financial counterparties The Economics and Monetary Affairs Committee of the European Parliament ( ECON ) passed a resolution requiring a formal reevaluation of the rules. On 7 February 2013, however, Commissioner Barnier made a statement that the ECON resolution had now been withdrawn, and that the RTS were to be adopted without objection. They are now backon schedule to come into force mid-march. For precise implementation details, please see below. Clearing Obligation Within six months of the RTS entering into force, CCPs providing clearing services must apply for authorisation or (in the case of third-country CCPs) recognition. Existing CCPs can continue to operate during the interim period. Within six months of a CCP being authorised or recognised, EMIR will determine whether the classes of OTC derivatives contracts that the CCP is able to clear should be made subject to the clearing obligation. At the same 5 To be jointly prepared with the European Banking Authority and the European Insurance and Occupational Pensions Authority. 6 With one exception see Update, above.

80 time, ESMA will decide the date on which the clearing obligation comes into force for that class of OTC derivatives contracts. ESMA expects to begin making these assessments in the first quarter of 2013, with the first clearing obligations entering into force shortly afterwards. Reporting Obligation The reporting obligation will be phased-in over time, based on asset class and whether or not there is a trade repository authorised for that class yet: Derivative class Trade repository authorised for that class? When? Reporting obligation start date: CDS and IRS Yes; TR registered before 1 April July 2013 As above Yes; TR registered between 1 April 2013 and 1 July days after a TR is registered for that class As above No TR registered by 1 July July 2015 (contracts reported to ESMA) All other OTC derivatives Yes; TR registered before 1 October January As above Yes, TR registered between 1 October 2013 and 1 July days after a TR is registered for that class** As above No TR registered by 1 July July 2015** (contracts reported to ESMA) OTC derivatives transactions outstanding on 16 August 2012 and still outstanding on the reporting obligation start date must be reported within 90 days of that date. OTC derivatives transactions outstanding on 16 August 2012 and no longer outstanding at the time of the reporting obligation start date need only be reported within three years of that date. Exceptions The rules on: - portfolio reconciliation (Art. 12); - portfolio compression (Art. 13); and - dispute resolution (Art. 14), will only begin to apply six months after the rest of the RTS comes into force. Note also that several RTS are still pending (see Other RTS, above) and so will not adhere to the timeframe above. These include RTS specifying the risk management procedures and additional collateral requirements for non-centrally cleared OTC derivatives contracts. 7 Or whichever of these is the earlier

81 Contacts Ash Saluja Partner T: +44 (0) E: Jason Harding Partner T: +44 (0) E: Will Dibble Partner T: +44 (0) E: Michael Cavers Partner T: +44 (0) E: 25 July This report is for general purposes and guidance only and does not constitute legal or professional advice and should not be relied on or treated as a substitute for specific advice relevant to particular circumstances. For legal advice, please contact your main contact partner at the relevant CMS member firm. If you are not a client of a CMS member firm, or if you have general queries about Law-Now or RegZone, please send an to: law-now.support@cmslegal.com so that your enquiry can be passed on to the right person(s). All Law-Now and RegZone information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments. CMS Legal Services EEIG (CMS EEIG), has its head office at: Barckhausstraße 12-16, Frankfurt, Germany. The contact address for CMS EEIG is info@cmslegal.com, its Ust-ID is: DE and it is registered on Handelsregister A in Frankfurt am Main with the registration number: HRA CMS Legal Services EEIG (CMS EEIG) is a European Economic Interest Grouping that coordinates an organisation of independent law firms. CMS EEIG provides no client services. Such services are solely provided by CMS EEIG s member firms in their respective jurisdictions. CMS EEIG and each of its member firms are separate and legally distinct entities, and no such entity has any authority to bind any other. CMS EEIG and each member firm are liable only for their own acts or omissions and not those of each other. The brand name CMS and the term firm are used to refer to some or all of the member firms or their offices. CMS EEIG member firms are: CMS Adonnino Ascoli & Cavasola Scamoni, Associazione Professionale (Italy); CMS Albiñana & Suárez de Lezo S. L. P. (Spain); CMS Bureau Francis Lefebvre S. E. L. A. F. A. (France); CMS Cameron McKenna LLP (UK); CMS China (China); CMS DeBacker SCRL / CVBA (Belgium); CMS Derks Star Busmann N. V. (The Netherlands); CMS von Erlach Poncet Ltd (Switzerland); CMS Hasche Sigle Partnerschaft von Rechtsanwälten und Steuerberatern mbb (Germany); CMS Reich-Rohrwig Hainz Rechtsanwälte GmbH (Austria); CMS Russia and CMS Rui Pena, Arnaut & Associados RL (Portugal). For more information about CMS including details of all of the locations in which CMS operates please visit: CMS Legal All rights reserved.

82 EMIR: key facts about the margining of non-cleared OTC derivative transactions Background EMIR (European Market Infrastructure Regulation No. 648/2012) requires that certain counterparties (please see below) to OTC derivative transactions not cleared through a central counterparty (non-cleared OTC transactions) put in place risk management procedures for the timely, accurate and appropriately segregated exchange of collateral in order to reduce counterparty credit risk. This requirement is commonly referred to as margining and applies to counterparties classified as (i) financial counterparties (FCs); or (ii) non-financial counterparties over the clearing threshold (as specified in Art. 11 of Regulation No. 149/2013) (NFC+s, and together with FCs, the FC/NFC+ counterparties). On 14 April 2014, the European Supervisory Authorities (ESAs) published common draft regulatory technical standards (RTS) setting out details of the proposed regulatory framework on margining. The consultation period with respect to these RTS ended on 14 July It is expected that the ESAs will submit the final draft RTS to the European Commission by the end of 2014 with the intention that the majority of the margining arrangements will enter into force as of 1 December The arrangements proposed under the RTS include (i) implementing risk management procedures which include the collection of collateral; (ii) various opt-outs from the requirement to exchange collateral; (iii) minimum eligibility criteria for collateral; and (iv) robust operational procedures for the exchange of collateral. This note discusses each of these arrangements in turn. Collection of collateral To prevent the build-up of uncollateralised exposures, FC/NFC+ counterparties will be required to collect collateral in the form of initial margin and variation margin. This will apply whether or not their counterparty is established in the EU, subject to the opt-outs outlined in section Opt-out options below. Initial Margin Initial margin will be collected gross (i.e., as a two-way payment without the possibility of netting initial margin amounts against each other) within the business day following the entry into a non-cleared OTC transaction. The idea is for initial margin to cover the potential future exposure of an FC/NFC+ counterparty due to its counterparty s default. Consequently, initial margin will need to be recalculated following a change to the portfolio of non-cleared OTC transactions between the counterparties (e.g., due to the termination of any non-cleared OTC transaction) and otherwise every 10 th business day, in each case to reflect movements in counterparties risk positions. The RTS require that initial margin is segregated from proprietary assets of any third party custodian and that the compliance by an FC/NFC+ counterparty with the requirements under the RTS on segregation is supported by legal opinion(s) to be obtained at least annually. In addition, the RTS require that initial margin is not subject to any rehypothecation or other reuse by a collecting FC/NFC+ counterparty. Variation Margin Variation margin will be collected net on a daily basis to reflect current exposures resulting from actual changes in market price calculated in accordance with the daily valuation requirement under Art. 11(2) of EMIR.

83 Opt-out options Various exceptions to the requirement to collect margin (initial margin, variation margin or both) will be available. These exceptions are broadly as follows: An FC/NFC+ counterparty may agree: o o not to collect initial margin with respect to (i) physically-settled FX forwards; (ii) physically-settled FX swaps; or (iii) the exchange of principal of a currency swap; not to collect initial margin if it or its counterparty belongs to a consolidated group whose aggregate month-end average notional amount of non-cleared OTC transactions for June, July and August of the relevant year is below a certain threshold. The applicable threshold amounts are as follows: From 1 December Threshold Amount trillion trillion trillion trillion 2019 onwards 8 billion o o not to collect initial and variation margin with respect to non-cleared OTC transactions with (i) nonfinancial counterparties below the clearing threshold; and/or (ii) counterparties exempt from EMIR (as specified in Art. 1(4) and (5) of EMIR); and not to collect initial and variation margin if the total amount of margin to be exchanged in relation to all non-cleared OTC transactions between it and its counterparty is equal to or lower than 500,000. In addition, an FC may agree not to collect initial margin where the total initial margin calculated to be exchanged for all non-cleared OTC transactions between counterparties at group level is equal to or lower than 50 million. Eligibility of collateral A wide range of asset classes will be eligible as collateral, including cash, gold, various types of debt securities and equities. Most asset classes will be subject to further conditions, such as credit quality assessments (using an approved internal rating based approach or external ratings), haircuts and concentration limits (of 50%, 10% and 40% respectively, depending upon the asset class) to ensure sufficient diversity of collateral pools. Operational procedures A variety of operational requirements will be imposed on FC/NFC+ counterparties to ensure that the margining arrangements are implemented in a manner which minimises any potential operational risks. Among other things, the RTS highlight the need for (i) detailed policy documentation with regards to the exchange of collateral; (ii) transparent senior management reporting of material exceptions; (iii) escalation procedures (both internally and between the respective counterparties); (iv) processes to verify the liquidity of collateral; and (v) annual testing of operational procedures for the exchange of collateral.

84 Contacts Jason Harding Partner, Financial Services and Products T: +44 (0) Eva Valentova Senior Associate, Financial Services and Products T: +44 (0) October 2014 This note is for general purposes and guidance only and does not constitute legal or professional advice and should not be relied on or treated as a substitute for specific advice relevant to particular circumstances. For legal advice, please contact your main contact partner at the relevant CMS member firm. If you are not a client of a CMS member firm, or if you have general queries about Law-Now or RegZone, please send an to: law-now.support@cmslegal.com so that your enquiry can be passed on to the right person(s). All Law-Now and RegZone information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments. CMS Legal Services EEIG (CMS EEIG), has its head office at: Barckhausstraße 12-16, Frankfurt, Germany. The contact address for CMS EEIG is info@cmslegal.com, its Ust-ID is: DE and it is registered on Handelsregister A in Frankfurt am Main with the registration number: HRA CMS Legal Services EEIG (CMS EEIG) is a European Economic Interest Grouping that coordinates an organisation of independent law firms. CMS EEIG provides no client services. Such services are solely provided by CMS EEIG s member firms in their respective jurisdictions. CMS EEIG and each of its member firms are separate and legally distinct entities, and no such entity has any authority to bind any other. CMS EEIG and each member firm are liable only for their own acts or omissions and not those of each other. The brand name CMS and the term firm are used to refer to some or all of the member firms or their offices. CMS EEIG member firms are: CMS Adonnino Ascoli & Cavasola Scamoni, Associazione Professionale (Italy); CMS Albiñana & Suárez de Lezo S. L. P. (Spain); CMS Bureau Francis Lefebvre S. E. L. A. F. A. (France); CMS Cameron McKenna LLP (UK); CMS China (China); CMS DeBacker SCRL / CVBA (Belgium); CMS Derks Star Busmann N. V. (The Netherlands); CMS von Erlach Poncet Ltd (Switzerland); CMS Hasche Sigle Partnerschaft von Rechtsanwälten und Steuerberatern mbb (Germany); CMS Reich-Rohrwig Hainz Rechtsanwälte GmbH (Austria); CMS Russia and CMS Rui Pena, Arnaut & Associados RL (Portugal). For more information about CMS including details of all of the locations in which CMS operates please visit: CMS Legal All rights reserved.

85 EMIR and its extra-territorial applicability SUMMARY To increase transparency in the OTC derivatives markets, the European Market Infrastructure Regulation ( EMIR ) requires certain market participants (the counterparties ) to centrally clear OTC derivative contracts of specified types (the clearing obligation ) or to apply risk mitigation techniques set out in Art. 11 of EMIR (the risk mitigation obligation ). Risk mitigation techniques include, amongst others, portfolio reconciliation, dispute resolution, valuation and margining. Importantly, the clearing obligation and the risk mitigation obligation extend to OTC derivative contracts where both counterparties are established in one or more countries outside the EU (each, a third country entity or TCE ) and: - the relevant OTC derivative contract has a direct, substantial and foreseeable effect within the EU; or - it is necessary or appropriate to prevent the evasion of any provisions of EMIR. The above is commonly referred to as extraterritoriality and this note outlines its potential consequences and current market developments. GENERAL CONSIDERATIONS TCE s counterparty status The clearing obligation and the risk mitigation obligation only attach to TCEs that would be subject to the relevant obligation if established in the EU. Therefore, as with EU counterparties, the extent to which these obligations are to apply to a TCE will be driven by determining (by analogy) its status under EMIR. Whilst the clearing obligation is only imposed on counterparties classified as financial counterparties ( FCs ) or non-financial counterparties over the clearing threshold (as specified in Art. 11 of Regulation No. 149/2013) ( NFC+s ), some of the risk mitigation techniques also extend to all counterparties, including non-financial counterparties below the clearing threshold ( NFC-s ). Although not strictly in the context of extraterritoriality, the European Securities and Markets Authority ( ESMA ) has expressed a view that status designations of TCEs should be assessed by counterparties in cooperation together, taking into account the nature of the activities undertaken by the relevant TCE counterparty. As this is not necessarily a clear-cut determination, the assumptions and conclusions drawn should be properly documented. Ultimately, the onus is on the relevant TCE to correctly determine its status designation under EMIR. In practical terms, counterparties are likely to seek representations regarding their TCE counterparty s status designation. If it is not possible to assess what a TCE s status under EMIR would be, ESMA has concluded that counterparties should assume that a TCE s status designation is NFC+ and take approaches to reflect this. Equivalence The applicability of the clearing obligation and the risk mitigation obligation to TCEs should always be subject to Art. 13 of EMIR which sets out principles to avoid duplicative or conflicting rules (the equivalence regime ). What is the thinking behind equivalence? At its simplest, its effect is meant to be that if at least one of the counterparties to an OTC derivative contract is established in an equivalent jurisdiction (i.e., whose legal

86 arrangements are declared by the EU Commission as equivalent to the relevant requirements under EMIR), the provisions of EMIR could be disapplied as that jurisdiction s framework would allow for an outcome similar to that of EMIR. As a result, only TCEs located in non-equivalent jurisdictions would need to ensure compliance with any requirements of EMIR that apply in relation to their OTC derivative contracts. However, the implementing acts on equivalence are still being developed by the EU Commission. To date, the EU Commission has mandated ESMA to provide technical advice on the equivalence of the legal regimes in Australia, Canada, Hong Kong, Japan, India, Singapore, South Korea, Switzerland and the United States. The EU Commission has yet to make any equivalence decisions based on ESMA s advice. At this point, there is little clarity as to how the equivalence regime under EMIR will operate (and interact with related legislation please see below). Going forward, many practical questions will need to be answered as to how TCEs can safely settle compliance issues relative to their derivative trading. WHERE ARE WE NOW? On 10 October 2014, the major provisions of regulatory technical standards (the RTS ) on the direct, substantial and foreseeable effect of [OTC derivative contracts] within the Union and to prevent the evasion of rules and obligations came into force. Their central purpose is to shed light on what a direct, substantial and foreseeable effect is meant to capture to ensure consistent application of the clearing obligation and risk mitigation obligation in extraterritoriality scenarios. We consider below the key features of these RTS and their impact on TCEs. Direct, substantial and foreseeable effect The RTS provide that an OTC derivative contract will have a direct, substantial and foreseeable effect within the EU in the circumstances as follows: - Firstly, when at least one TCE has (with respect to such OTC derivative contract) the benefit of a guarantee provided by an EU guarantor whose status is an FC (i.e., potentially holding a significant market position). The thinking behind this is that a default of such TCE under such OTC derivative contract would impact that EU guarantor - which would be obliged to assume the resulting liability - thereby importing risks to OTC derivatives markets in the EU. Such guarantee is to meet two cumulative thresholds in order to qualify. In broader terms, it must: - cover the liability under one or more OTC derivative contracts for an aggregated notional amount of at least EUR 8 billion (or cover only a part of such liability, in which case the above threshold amount is to be proportionally reduced); and - be at least equal to 5 per cent. of the EU guarantor s total current exposures (as defined in the Capital Requirements Directive) under OTC derivative contracts. The RTS also require that the liability that arises from these OTC derivative contracts must itself at least reach the set threshold. If not, such OTC derivative contracts would not be considered to have a direct, substantial and foreseeable effect within the EU even where (i) the maximum amount of the guarantee reaches (or exceeds) that threshold, and (ii) the threshold regarding the EU guarantor s current exposures is met. Crucially, the applicability of both thresholds is to be assessed both at the time such OTC derivative contract is entered into and on an ongoing basis. An OTC derivative contract can become covered by the RTS after it has been entered into and so it follows that the clearing obligation or the risk mitigation obligation may subsequently apply with respect to an OTC derivative contract after it has been entered into, even if it has been entered into on the basis that these obligations will not apply. - Secondly, an OTC derivative contract will have a direct, substantial and foreseeable effect within the EU, if it has been entered into by two TCEs through their branches located in the EU and these TCEs would be FCs if established in the EU. This is to address the regulator s concern that these branches may control a significant share of the OTC derivatives markets in the EU and so the inapplicability of the relevant EMIR rules with respect to OTC derivative contracts involving such branches could be a cause of potential market disruptions. For example, activities of these branches could significantly influence market liquidity due to their strong market position. 2

87 A possible implication of the above is that the clearing obligation or the risk mitigation obligation may extend to TCE subsidiaries of FCs established in the EU (if at least one of them benefits from a guarantee provided by its parent with respect to its OTC derivative contracts). However, the current market expectation is that it should be the TCE with the guarantee (in collaboration with the FC guarantor) that are to be responsible to ensure compliance with these obligations as these are the only entities that can assess whether the applicable thresholds with respect to the guarantee have been met at any given time. The fact that the RTS anticipate an ongoing assessment of the thresholds raises a number of issues in particular, pricing and valuation uncertainties (as a result of clearing obligation or risk mitigation obligation (primarily margining) being potentially applicable in the future) and difficulties in ensuring compliance if the other counterparty is not cooperative. The market practice around these issues (and possible mitigants) is yet to be settled and so it is currently not clear how the OTC derivatives market will respond to changes brought in by the RTS. Evasion of rules The RTS also establish cases where it is necessary to prevent the evasion of provisions of EMIR in the context of OTC derivative contracts between two TCEs. Briefly, the RTS apply to an OTC derivative contract if the way in which it has been concluded is considered (having regard to all relevant circumstances and arrangements related to it) as having the avoidance of the application of EMIR as its primary purpose. If an OTC derivative contract lacks a clear business rationale or economic justification, it could be taken as having defeated the object, spirit and purpose of any provision of EMIR that would otherwise apply and, therefore, be considered to be evasive. INDIRECT IMPACT EMIR inevitably also bites in the event of cross-border transactions (i.e., where a TCE is transacting with an EU counterparty). This is most obvious when it comes to the clearing obligation. EMIR makes it explicit that this obligation applies with respect to OTC derivative contracts between an EU counterparty (which is an FC or an NFC+) and a TCE which would be subject to this obligation if it were established in the EU (please see TCE s counterparty status above). However, ensuring compliance is of lesser concern for a TCE as the prevailing view across the OTC derivatives market is that the responsibility lies with an EU counterparty. So far as the risk mitigation obligation is concerned, there is no such express authority in EMIR. Nevertheless, ESMA has advised that this obligation applies in the above context even though the TCE would not itself be subject to EMIR and it is an EU counterparty which is to take appropriate actions so that the relevant risk mitigation techniques are employed with respect to the relevant OTC derivative contracts. The position should not be any different when it comes to any other requirement imposed by EMIR. TCEs are in practice required by their EU counterparties to agree arrangements ensuring compliance with EMIR - with EU counterparties being unlikely to trade derivatives with TCEs refusing to cooperate. Contacts Jason Harding Partner, Financial Services and Products T: +44 (0) E:jason.harding@cms-cmck.com Eva Valentova Senior Associate, Financial Services and Products T: +44 (0) E:eva.valentova@cms-cmck.com 18 November

88 This note is for general purposes and guidance only and does not constitute legal or professional advice and should not be relied on or treated as a substitute for specific advice relevant to particular circumstances. For legal advice, please contact your main contact partner at the relevant CMS member firm. If you are not a client of a CMS member firm, or if you have general queries about Law-Now or RegZone, please send an to: law-now.support@cmslegal.com so that your enquiry can be passed on to the right person(s). All Law-Now and RegZone information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments. CMS Legal Services EEIG (CMS EEIG), has its head office at: Barckhausstraße 12-16, Frankfurt, Germany. The contact address for CMS EEIG is info@cmslegal.com, its Ust-ID is: DE and it is registered on Handelsregister A in Frankfurt am Main with the registration number: HRA CMS Legal Services EEIG (CMS EEIG) is a European Economic Interest Grouping that coordinates an organisation of independent law firms. CMS EEIG provides no client services. Such services are solely provided by CMS EEIG s member firms in their respective jurisdictions. CMS EEIG and each of its member firms are separate and legally distinct entities, and no such entity has any authority to bind any other. CMS EEIG and each member firm are liable only for their own acts or omissions and not those of each other. The brand name CMS and the term firm are used to refer to some or all of the member firms or their offices. CMS EEIG member firms are: CMS Adonnino Ascoli & Cavasola Scamoni, Associazione Professionale (Italy); CMS Albiñana & Suárez de Lezo S. L. P. (Spain); CMS Bureau Francis Lefebvre S. E. L. A. F. A. (France); CMS Cameron McKenna LLP (UK); CMS China (China); CMS DeBacker SCRL / CVBA (Belgium); CMS Derks Star Busmann N. V. (The Netherlands); CMS von Erlach Poncet Ltd (Switzerland); CMS Hasche Sigle Partnerschaft von Rechtsanwälten und Steuerberatern mbb (Germany); CMS Reich-Rohrwig Hainz Rechtsanwälte GmbH (Austria); CMS Russia and CMS Rui Pena, Arnaut & Associados RL (Portugal). For more information about CMS including details of all of the locations in which CMS operates please visit: CMS Legal All rights reserved. 4

89 THE CMS EMIR TEAM The Capital Markets and Derivatives Groupp at CMS combines leading derivatives, clearing, regulatory and insolvency expertise to advise on developments in the clearing of OTC O derivatives, membership of central clearing houses, clearing rules, collateral transformation and regulatory change. The team has a broad range of experience in advising clients on o the impact of EMIR, including the negotiation of documentation with potential clearing members, advising on the risks and structure relating to the documentation provided by various CCPs (such as LCH Clearnet) and providing legal opinions relating to the risk of insolvency of clearing members. The Capital Markets and Derivatives Groupp is currently assisting a wide w range of clients as to the ongoingg implementation of EMIR, given the complexity of the regulation and the regulatory technical standards. CONTACTS IN LONDONN Will Dibble Partnerr Financial Services & Products E: will.dibble@cms-cmck.com T: +44 (0) Ash Saluja Partner Financial Services & Products E: ash.saluja@cms-cmck.com T: +44 (0)) Emma Riddle Partnerr Banking E: emma.riddle@cms-cmck.com T: +44 (0) Eva Valentova Senior Associate Financial Services & Products E: eva.valentova@cms- cmck.comm T: +44 (0)) Jason Harding Partner Financial Services & Products E: jason.harding@cms-cmck.com T: +44 (0)) Chris Clark Associate Financial Services & Products E: chris.clark@cms-cmck.com T: +44 (0) Further information, including a list of our offices, can be foundd at CMS Cameron McKenna LLP 2015.

90 Raj Bhattt Lawyer Financial Services & Products E: T: +44 (0)) Kirsty Templar Lawyerr Financial Services & Products E: T: +44 (0) Jo Bennett Lawyer Financial Services & Products E: T: +44 (0)) Juliet Chrispin Lawyerr Financial Services & Products E: T: +44 (0) YOUR CONTACTT IN PRAGUE Pavla Křečková Partner Head of local Banking and Finance E: T: Further information, including a list of our offices, can be foundd at CMS Cameron McKenna LLP 2015.