EMIR addresses the risk of OTC trading by imposing new requirements:
- Clearing: standardised derivative contracts should be cleared through central counterparties in order to reduce the risk in the financial system
- Margin and capital: clearing counterparty shall have permanent, available and separate initial and variation margins in the form of highly liquid collateral
- Reporting: all OTC derivative contracts should be reported to trade repositories
Clearing obligation
Which institutions?
The clearing obligation applies to financial counterparties (banks, insurers, asset managers, etc.) and to non-financial counterparties. There will be exemptions for pension funds (3-year grace period) and intra-group transactions.
To comply with the new clearing obligation, the counterparty should be a clearing member, a client of a clearing member (direct client) or a client of a client by having agreed indirect clearing arrangements. This strategic choice will depend on the best compromise between protection (full omnibus-account model or individual segregation) and operational efficiency.
Which products?
ESMA will assess the application of the clearing obligation for OTC derivatives based on a top-down approach (from ESMA to local market) and a bottom-up approach (from local market to ESMA). The following criteria are to be followed in identifying the class of contract subject to clearing:
- Degree of standardisation
- Volume of trading and liquidity
- Availability of pricing information
Margin and capital
The counterparty risk mitigation on cleared OTC derivative transactions forces counterparties to pay (from day one) initial and variation margins in highly liquid collateral (cash, gold, government bonds, etc.).
No cleared transactions will be subject to additional capital requirements.
Trade repositories
Daily reporting to the competent authority will be required for all trades (OTC cleared, OTC not cleared but also exchanged ones) in order to identify potential pockets of systemic risk.
These new trade repositories (around 30 fields to be reported) not only concern trades openings but also modifications and terminations.
The new EMIR was published in the Official Journal of the European Union on 27 July 2012, and comes into force on 16 August 2012.
The following key milestones are expected in the next coming months:
Besides EMIR, a new set of regulations and directives such as MiFID II, MiFIR, Market Abuse, Central Security Depositaries and CRD IV are having a global impact on the OTC markets and the global trading and post trading value chain.
It is crucial to have a global understanding of business impacts and future business models within this regulatory framework.
EMIR refers to several challenges and will require the development of organisational and operational actions in order to meet the proposed deadline of the summer 2013.
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Challenges
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Key actions
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Collateral and liquidity management
- What are the expected additional funding needs?
- Do I have the right tools to efficiently monitor and manage the collateral requirements?
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- Assess the impact on your products and portfolio (cleared versus not cleared)
- Implement a portfolio reconciliation process
- Adapt collateral management infrastructure and organisation (e.g. increase STP level)
- Assess your additional daily funding needs (capital and margin)
- Choose a set-up with fewer clearers than executing brokers so as to maximise the netting effect
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OTC derivatives valuation
- How do I set up an effective valuation approach with the right information at the right time?
- Can I outsource the valuations process?
- How do I maintain good integration between the trade, pricing, valuation and collateral engines?
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- Define your approach for the best OTC derivatives valuation (counter-check CCP prices, using robust valuation process and independent sources)
- Organise daily reliable and verifiable monitoring of risk on the derivatives’ positions and their contribution to the overall risk profile of your portfolio
- For complex instruments, possibly delegate to 3rd party middle office providers
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Business model
- Which part of my business could I outsource?
- How do I select the right clearing member and/or CCP?
- What do I have to do to become a clearing member?
- How do I need to organise my accounts?
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- Understand the regulations and the global value chain issues
- Sign a new set of documentation for cleared OTCs with a clearing broker
- Sign a collateral agreement
- Define strategic options:
- Select your service provider model (CCPs or clearing members),
- Define your counterparty risk level with your providers (accounts segregation & protection level, operational efficiency, etc.)
- Seamless integration between trade, post trade and collateral activities
- Evaluate whether you have the skills/mass to perform collateral management in-house or through outsourcing
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Reporting
- What will the impact be on my database?
- Do I have all the information available in my system?
- Can I outsource this business and to whom?
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Update your processes and IT applications in order to:
- Identify and provide required information
- Identify transactions to report
- Build and send your daily reporting file
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Deloitte Luxembourg can help you to understand and assess potential impacts that EMIR regulation will have on your business. We can assist you from defining your strategic plan to implementing EMIR requirements across your organisation.
Deloitte Luxembourg delivers sustained improvements in business performance to its clients in all aspects of enterprise transformation including strategy, process, and information technology. We are known for our highly respectful, flexible, and collaborative working style that gives us the ability to generate employee buy-in and to transfer knowledge and skills.
Our multidisciplinary team of consultants, including specialists in strategic planning, regulatory consulting, collateral management (margining and valuation), credit risk mitigation, organisation and information systems technology, will complement your team and help you to create, defend and/or re-invent your business and to develop economic models by guiding you through the complexities of the trade and post-trade environments.
Shortcomings, such as a lack of counterparty risk management and a lack of transparency within the over the counter (OTC) derivatives market, were highlighted during the financial crisis in 2008 by the default of Lehman and the near-collapse of Bear Stearns. In response, G20 countries met in Pittsburgh in September 2009 and passed a resolution stating:
