The EU rejection of EMIR on February 5, 2013 is specifically directed at non-financial companies, such as airlines, agriculture firms and other corporates that use derivatives to hedge against commercial activities. The ruling likely provides much-deserved relief to non-financial hedgers by modifying, reducing or potentially eliminating a threshold-based clearing obligation.
Under the European Markets Infrastructure Regulation (EMIR), Article 10 prescribes that where a non-financial counterparty takes positions in OTC derivative contracts and these positions exceed a defined clearing threshold; the non-financial counterparty must notify authorities and clear all future derivatives. In essence, the non-financial counterparty is “knocked-in” to mandatory regulations based exclusively on volumetric considerations.
This rejected knock-in schedule which effectively changes the status of a non-financial end-user to a more substantively regulated entity is at odds with similar Dodd-Frank provisions under U.S. law.
Under Dodd-Frank, the end-user exception is less prescriptive and generally allows bona-fide end-users to maintain their status regardless of any notional-based threshold. That is, end-users using swaps to hedge or mitigate commercial risk will generally not be required to clear their swaps even in the instance that a certain threshold is breached.
Compared to EMIR, the Dodd-Frank end-user provisions provide for more trading certainty by allowing end-users to maintain their status as end-users perpetually, based on activity-based analysis rather than an aggregate notional value perspective.
Another issue that was explicitly rejected by the EU was the aggregation of thresholds that would knock end-users in to a compulsory clearing regime by combining all asset classes. This proposed requirement was likely the most contentious. The asset class aggregation proposal contemplates significant burdens onto firms that are at risk of implementing systems to account for only a de minimus activity in one asset class just because its activities in another asset class have exceeded certain notional limits.
The EU’s rejection of the technical standards, as it relates to commercial hedge activities, now provides market participants with more clarity that the rules should be, and are being harmonized across borders to avoid regulatory arbitrage. More significantly, market participants now have additional regulatory clarity based on their status, such as Dodd-Frank prescribes, as opposed to extreme variability and uncertainty, as was proposed in EMIR and now rejected by the EU.
This is an important development. The stage is now set to harmonize the cross-border application of the end-user clearing exception. For example, end-user market participants, or alternatively, their agents, will likely move quickly to implement hedge strategy operational processes, including data collection of inter-affiliate swaps, swap guarantee accounting and straight-through reporting, while maintaining consistency of a perpetual status.
Daniel Parker, vice president, SunGard’s capital markets business