European companies have been struggling to implement EMIR, which requires them to report all derivative contracts from February 12, amid widespread confusion and culminating in the European Securities and Markets Authority (ESMA) sending a letter to the EC seeking clarification on the definition of derivatives, which varies by type and member country.
This letter was sent on February 14 – two days after the deadline on which companies were due to begin daily reporting on derivative transactions. The letter highlights “that there is no single, commonly adopted definition of derivative or derivative contract in the European Union, thus preventing the convergent application of EMIR”.
This letter relates, in particular, to foreign-exchange forwards and physically settled commodity forwards. Different interpretations of what constitutes a derivative across the EU member states would result in the inconsistent application of EMIR.
One notable inconsistency is that FX forwards are not viewed as derivatives in the UK whereas they are elsewhere in the EU. By contrast, FX forwards are highly regulated derivatives in France.
“ESMA has taken this action very late,” says Marcos Barrabés-Rebollo, a consultant at treasury consultancy Zanders. “I also see it as a movement to push the FCA [UK regulator Financial Conduct Authority] to declare that FX forwards are in scope, like in the rest of the EU.
“So in my view ESMA expects that UK market participants will also start reporting FX forwards in the coming months.”
A view that is shared by James Coiley, partner at law firm Ashurst specializing in derivatives.
“The problem is that EMIR refers here to Mifid [Markets in Financial Instruments Directive], and Mifid as a directive is implemented through national-level legislation,” he says.
“The UK, in implementing Mifid, made choices as to what is in and out of scope in terms of FX and certain other products. With the FCA so far sticking to that position, ESMA is citing the need for harmonization as a basis to get the EU-level rules changed so as to pull the UK position into line.”
However, ESMA spokesman Reemt Seibel highlighted that the interpretation of Mifid relates to all EU members.
“Given the definition under the current Mifid is not harmonized across EU member states, ESMA asked the Commission to provide legal clarification as otherwise this could have a detrimental effect on the consistent application of EMIR,” he says.
“Lacking this clarification, ESMA understands that national regulators who police EMIR reporting will not implement the relevant EMIR provisions for derivative contracts that are not clearly identified as derivatives contracts across the Union.”
Seibel adds: “This particularly goes for FX forwards with a settlement date up to seven days, FX forwards concluded for commercial purposes, and physically settled commodity forwards.”
However, despite this uneven interpretation of which financial instruments constitute a derivative across the EU, market specialists also cite difficulties encountered with the general implementation of EMIR.
“That ESMA is seeking clarification from the Commission on FX forwards, a few days after the official start date, epitomizes the whole chaotic story,” says Martin O’Donovan, deputy policy and technical director at the Association of Corporate Treasurers (ACT).
“Maybe this [clarification request] is an opportunity for the Commission to remove some of the bureaucratic reporting burden falling on companies that in any case pose no systemic risk.”
EMIR is the EC’s response to the commitment by G20 countries to address risks related to the OTC derivative markets. Since derivatives have become synonymous with the financial crisis, the regulation is aimed at increasing transparency in the derivatives market thereby reducing and minimizing systemic risk by reducing counterparty and operational risk.
Companies are required to report derivatives to approved trade repositories, of which there are six. Daily reports must be submitted on any new or maturing derivative trades and any changes to existing ones – and for corporates whose derivatives exceed given thresholds, they also have to clear them via a central clearing house.
However, the names of the trade repositories were only approved three months before the February deadline, so that while the new regulation was put in place, the infrastructure to facilitate the reporting was severely lacking.
“One lesson is that allowing just three months between official approval of the first trade repositories and the reporting start date was grossly inadequate,” says O’Donovan.
“It was always going to be practically impossible within the set timescales for six trade repositories to sign up the entire population of derivative users in Europe, create new systems and be receiving a back book of deals done since August 2012, all from virtually nothing in place beforehand.”
And trade repositories were not the only ones given an impossible task. The issuers of legal-entity-identifier references, the systems providers, the banks and corporate customers had implementation projects to complete with insufficient time, adds O’Donovan.
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| Monica Gogna, partner at Pinsent Masons |
Monica Gogna, a partner in the financial regulation team at law firm Pinsent Masons, says: “The implementation of EMIR is symptomatic of the nature of the raft of legislation that came through during the economic crisis, with lots of good intentions but not enough time to sort through the minutiae of detail that is required when firms are asked to overhaul their internal systems and controls.”
Companies have also struggled with formatting and were at a loss as to how to tabulate their reports, which were subsequently rejected by the trade repositories. And trade repositories have struggled with the flood of reporting.
“Sadly, the trade repositories have been so overwhelmed that some customers trying to get their data input files into the correct format have been struggling to get the help and advice they need,” says ACT’s O’Donovan.
Although most firms are on the way to identifying the changes required to their systems by EMIR, there is still a degree of uncertainty on certain key implementation issues from both the national and European regulators, says Pinsent Masons’ Gogna.
Lars Cordi, vice-president and treasurer of Carlsberg, says: “New financial regulation, such as EMIR and Sepa, is certainly a challenge for us. In particular, it is very time consuming for us, for our people to get to grips and understand new regulation and EMIR, especially, where we have to adjust our reporting.
“We have to try to find the balance. We need to prioritize our time.”
The EC is likely to answer ESMA’s letter through a Q&A session to clarify the situation rather than with a new regulation on FX forwards, notes Gogna.
Going forward there is likely to be a period of bedding down. “After an appropriate period has past – six months or even a year – regulators will start to focus on the companies that are non-compliant,” she says.