Derivatives Alerter: FX Forwards – A Possible Solution Under EMIR Review Proposals
The EU Council has just released a revised draft of a proposed Regulation to amend EMIR – link here. Although there is no specific timetable for the adoption of this proposed Regulation, this does show the direction of the EU's thinking and provides some possible solutions to issues that are currently vexing substantial numbers of participants in the European OTC derivatives markets.
The proposed amendments to EMIR include:
• Physically Settled Forward FX Transactions and VM. Physically settled forward FX transactions ("FFX") will become within scope for mandatory VM on 3 January 2018. This is proving an operational and documentation challenge for buy-side entities (UCITS and AIFs) and sell-side entities who do not trade any OTC derivatives products between themselves other than physically settled FFX. The proposed amendments would take physically settled FFX out of scope for mandatory VM (except for physically settled FFX between two credit institutions).
Two things to note about this proposal. First, this only applies to mandatory VM. The other aspects of the EMIR Margin Rules would continue to apply – including the need to have a compliant netting agreement in place for these transactions and to have risk management procedures in place. Second, it is unlikely that the proposed amendments will be in place before 3 January 2018. Therefore, to enable this amendment to be of practical use and address the current documentation challenges, there would need to be some indication of regulatory forbearance pending the amendment coming into effect.
• Securitisation SPVs. The previous draft of the proposed amendments would have added "securitisation special purpose entities" (as defined in CRR) as a new class of financial counterparties under EMIR. This has been dropped in the revised draft.
• Transaction Reporting. For ETDs, it is proposed that the CCP takes sole responsibility for transaction reporting, although two variants of the proposed amendments are included – one would extend the CCP's responsibility to cover any indirect clearing client's transaction reporting obligations, whereas the other would only cover clearing members and direct clients. For OTCs entered into between a FC and a NFC-, it would be the FC that has sole responsibility for transaction reporting.
• Pension Scheme Temporary Deferral. EMIR provided a 3-year temporary deferral of any mandatory OTC clearing for pension schemes. This was to allow time for the development of viable technical solutions to permit pension schemes to participate in clearing without adversely affecting the rights of future pensioners - in other words, solutions that would allow pension schemes to post non-cash margin, since pension schemes do not have sufficient cash as they are almost fully invested in long dated fixed income assets. As no such viable technical solution have been developed (yet), a further 3-year deferral with a possible further 2-year extension is now proposed, again to allow for viable technical solutions to be developed.
Although the final form of the amendments, and the date they will become effective, is not yet known, it is positive to see that the EU legislators are considering changes to deal with some of the practical problems that EMIR threw out and which many participants in the derivatives are still endeavouring to deal with in a proportionate and effective manner.