www.pwc.co.uk EMIR - What should Hedge Funds be doing?
Sept 2009 2008 credit crisis 2008: OTC market collapse Weaknesses revealed in crisis Collapse of Bear Stearns and Lehmans Heightened levels of counterparty credit risk resulting in the decline of lending and market liquidity AIG s collapse AIG s collapse showed a lack of transparency in OTC derivatives positions and exposures G20 commitment G20 agrees the derivatives reform pillars: Reducing counterparty risk, esp. by stipulating clearing requirements Reducing operational risk (incl. standardisation & electronic processing); Increasing transparency (Reporting obligations and trade repositories (TRs)); Improving market integrity. All standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties. OTC derivative contracts should be reported to trade repositories. Non centrally cleared contracts should be subject to higher capital requirements. - G20 Pittsburgh summit European Markets Infrastructure Regulations (EMIR) 2
Products in scope for EMIR Derivatives, derivatives, derivatives EMIR derivative financial instruments defined under the Markets in Financial Instruments Directive (MiFID)*. General scope of EMIR Derivatives based on: Equities Currencies Interest rates and yields Commodities Credit instruments Products out of scope of EMIR Physically settled spot FX Physically settled commodities Cash equities Bonds Repos Stock borrowing/lending *Directive 2004/39/EC of the European Parliament and the Council of 21 April 2004 on markets in financial instruments amending Council Directives 85/611/EEC and 93/6/EEC and Directive 2000/12/EC of the European Parliament and of the Council and repealing Council Directive 93/22/EEC FX forwards pose particular challenges: exempt from EMIR in the UK and certain other EU member states when used for commercial purposes Slide 3
EMIR The Key Requirements EMIR introduces three sets of core obligations for derivative counterparties, aimed at increasing transparency and decreasing counterparty credit risk. 1 Risk mitigation All OTC derivatives contracts that are not cleared by a CCP will be subject to strict risk mitigation requirements 2 Reporting obligations All derivatives, not only OTC derivatives, must be reported to an ESMA authorised trade repository 3 Clearing obligations All classes of OTC derivatives declared subject to the EMIR clearing obligation will have to be cleared through an EMIR authorised CCP CCP/TR regimes To facilitate compliance with these obligations, CCPs must be available to clear trades and TRs to receive reporting. Both entities must be regulated to a robust and consistent standard. 4
EMIR the obligations and compliance dates EMIR Obligation Compliance Date Obligation Overview 1 Risk mitigation requirements for all non-cleared over-the-counter (OTC) derivative contracts Timely Confirmations March 15, 2013 Contracts shall be confirmed within defined timeframes. Timing is phased, and applies to FCs and all NFCs. FCs shall have necessary procedures to report on a monthly basis the number of unconfirmed OTC derivative transactions that have been outstanding for more than five business days. Daily Valuations March 15, 2013 FCs and NFC+s shall mark-to-market the value of non-cleared outstanding contracts. Where market conditions prevent marking-to-market, marking-to-model shall be used. Portfolio Compression Portfolio Reconciliation September 15, 2013 September 15, 2013 FCs and NFCs (+500 contracts outstanding uncleared) shall have procedures to regularly analyse the possibility of conducting portfolio compression, with validation/reasoning provided where deemed not appropriate. FC and NFCs shall agree upon arrangements for the reconciliation of portfolios (frequency of this is based on trade volume/counterparty type). Dispute Resolution September 15, 2013 FCs and NFCs shall have detailed procedures and processes related to identification, recording and monitoring of disputes. Reporting of disputes to authorities for some long-standing disputes. Margin and Collateral Q1 2015 FCs must maintain procedures for segregated exchange of collateral. FCs shall hold proportionate amount of capital to manage the risk not covered by appropriate exchange of collateral. 2 Reporting obligation for ALL derivative contracts (OTC and exchange-traded) Transaction reporting All asset classes: February 12, 2014 All counterparties must report trade details for cleared and non-cleared trades (with requirements phased in by asset class type, and historical trade reporting from August 16, 2012). Counterparties shall keep records of derivative contracts that have concluded, and any modifications, for at least 5 years following the termination of the contract. 3 Clearing obligations for eligible OTC derivatives contracts Clearing Q2-3 2014 (est.) Financial Counterparties and Non-Financial Counterparties above the clearing threshold are required to clear eligible transactions. 5
Key issues for hedge funds Selecting a clearing broker Liability for outsourced obligations Higher margin unavoidable Extra-territoriality: The wild card The clearing brokers are expecting to be selective about which clients they provide services too Bottlenecks and onboarding capacity issues expected No ability to delegate liability to execution, clearing and reporting agents Firms must be able to demonstrate adequate due diligence and supervision of agents EU legislators likely to set uncleared margin and collateral levels as high, if not higher, than cleared margin levels to encourage clearing Sell side firms looking to cash in on collateral optimisation Shop around for the best deal EMIR contains a broad clause that captures transactions in which no EU counterparty is involved ESMA published rules in Q4 2013 6
What should you being doing now? 1. Classify Counterparties Your funds and your counterparties Register NFC+ status with FCA 2. Review and comply with obligations already in force Confirm compliance or mobilise project Upgrade confirmation processes Upgrade collateral processes 3. Prepare for transaction reporting Review data elements and plug gaps Determine whether to report via Trade Repository or delegated reporting route 4. Get ready for clearing Checklist Review clearing broker requirements and issue RFP 5. Review legal documentation Legal docs will need updating for new obligations and for clearing 7
Contacts Crispian Lord Partner Tel: +44 (0) 20 7804 8148 Mobile: +44 (0) 7977 198677 Email: crispian.lord@uk.pwc.com Che Sidanius Director Tel: +44 (0) 20 7804 8762 Mobile: +44 (0) 7808 035854 Email: che.s.sidanius@uk.pwc.com James Chrispin Director Tel: +44 (0) 20 7804 2327 Mobile: +44 (0) 7711 109942 Email: james.chrispin@uk.pwc.com Betsy Dorudi Senior Manager Tel: +44 (0) 20 7213 5270 Email: betsy.dorudi@uk.pwc.com Neha Chandgothia Manager Tel: +44 (0) 20 7804 0390 Mobile: +44 (0) 7942 756863 Email: neha.chandgothia@uk.pwc.com 8
Appendix 9
Counterparty definition under EMIR EMIR distinguishes two types of counterparties: Financial Counterparties (FCs) and Non-financial Counterparties (NFCs) Financial Counterparties (FC) Non-Financial Counterparties (NFC+) Any entity authorised in accordance with EU law as an investment firm, credit institution, insurance undertaking, assurance undertaking, reinsurance undertaking, UCITS and its management company, institution for occupational retirement provision and an alternative investment fund managed by AIFMs authorised or registered in accordance with AIFMD. FCs are subject to the most stringent EMIR obligations. Any other entity that is established in the EU which is not an FC or a CCP; and whose positions in OTC derivatives (excluding hedging positions) exceed a specified clearing threshold (gross notional value), assessed on a 30 day rolling average and in that period remains above this threshold: 1. Credit = 1bn 2. Equity = 1bn 3. Interest rate = 3bn 4. Foreign exchange = 3bn 5. Commodities = 3bn NFC+s are subject to obligations similar to those for FCs. Non-financial Counterparties (NFC-) Any other entity that is established in the EU which is not an FC or a CCP; and whose derivative trading activities are under the clearing threshold. NFC-s are not subject to mandatory clearing, daily valuation, and non-centrally cleared margin requirements. 10
Application of EMIR rules The application of the three core EMIR obligations varies for each counterparty type (FC, NFC+, NFC) Clearing obligation?* Reporting obligation? Risk mitigation measures? Risk mitigation margin requirements? Risk mitigation capital requirements? Financial counterparties (FCs) Yes Yes Yes Yes Yes Non-financial counterparties (NFC+) Yes Yes Yes** Yes No Non-Financial Counterparties (NFC-) No Yes Yes** No No The clearing obligation will only apply to classes of OTC derivatives which are mandated by EU law to be cleared. **Only FCs are required to report any unconfirmed trades that are outstanding for more than 5 business days and report disputes between counterparties relating to OTC derivative contracts. NFC-s not required to undertake daily valuations. Notes Under EMIR, the clearing obligation applies to transactions between financial counterparties, non-financial counterparties whose positions (excluding certain hedges) exceed a specified clearing threshold and non-eu entities which will be captured by EMIR extra-territorial rules. EMIR requires financial counterparties to hold appropriate capital for uncollateralised risk, the level of capital is yet to be defined. However, capital requirements will be dealt with under Basel III and Solvency II. Some large corporations that are not financial counterparties may also have to comply depending on the size of their Treasury functions. The Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) in their second consultative document on margin requirements for non-centrally cleared derivatives (15 March 2013) state that margin requirement only apply to financial firms and systemically important non-financial entities. 11
Key compliance dates The EMIR level 1 text came into force on August 2012, however most of the key obligations are set to come into force over a staggered timeframe from March 2013. 16 August 2012 EMIR came into force Historic transaction reporting period commenced 1 September 2013 Second timely confirmation deadlines introduced Q4 2013 (est) CCPs authorised Disclosure and segregation requirements for clearing members 1 March 2014 Third timely confirmation deadlines introduced Q2-3 2014 (est.) Third country rules take effect 1 September 2014 Fourth timely confirmation deadlines introduced Key: Risk mitigation Reporting Clearing Third country rules 15 March 2013 Technical Standards for CCPs, TRs and most obligations for firms in force (phased in) Mark to market valuation for uncleared trades (FC, NFC+) First timely confirmation deadlines introduced 15 September 2013 Dispute resolution, portfolio compression and reconciliation for non-centrally cleared derivatives in effect 12 February 2014 Commencement of reporting obligation. Reporting for collateral follows 180 calendar days later. Q2-3 2014 (est.) First set of clearing obligations commence 1 December 2015 (est.) Margin for non-centrally cleared trades in effect. Phase-in period for implementation Some implementation dates set by counterparty classification, type of product and frequency of trading 12
EMIR accelerators and tools EMIR tools/materials Key legislation Governance and rules identification and analysis Sample policies and procedures Introductory and targeted EMIR training EMIR FAQs Implementation guidance 13
points of view We have produced a series of thought leadership pieces, examples of which are: All clear? Our thoughts on how to ensure you are operationally ready to meet the new clearing, reporting and collateral requirements. Securing your access Securing access to clearing services is more than just a procurement exercise. Our expertise and insight can help you achieve the right result. Voice of the customer Changing demand requires solutions along the value chain. Forward-looking banks are listening to what clients really want and responding accordingly. 14
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