On the 14th October 2020, the Malta Financial Services Authority (“MFSA”) issued a circular on its findings following the compliance inspections related to Regulation 648/2012 ‘The European Markets Infrastructure Regulation’ (“EMIR”) which the authority conducted in 2020.
The circular is addressed to all market participants, especially to those entities which enter into derivative contracts and which fall within the scope of EMIR. The MFSA noted that from the compliance inspections it carried out, the majority of the issues that were found related to the introduction of Regulation 834/2019 (“EMIR Refit”) as a number of market participants failed to adhere to the changes implemented through this regulation.
Counterparty Classification and Clearing Obligation Thresholds
One of the changes brought by EMIR Refit was the introduction of a new regime to determine when Financial Counterparties (“FC”) and Non-financial Counterparties (“NFC”), as defined under EMIR, are subject to the clearing obligation.
The new regime requires that FCs and NFCs decide whether or not to calculate their positions in OTC derivative contracts against the clearing thresholds in gross notional value. In the event that counterparties decide to calculate their clearing thresholds, they should for every 12 months of operation, calculate their aggregate month-end average position for the previous 12 months. Where a FC or an NFC decides not to calculate its positions against the clearing thresholds, it will become subject to the clearing obligation for all OTC derivatives pertaining to any class of OTC derivatives for which the clearing obligation is applicable.
Furthermore, if a FC calculates its positions and the result of that calculation exceeds the clearing threshold, the FC will become subject to the clearing obligation for all OTC derivative contracts pertaining to any class of OTC derivatives for which the clearing obligation is applicable. In the case of an NFC, where an NFC calculates its positions and the result of that calculation exceeds the clearing thresholds, the NFC will become subject to the clearing obligation only for the OTC derivative contracts in asset classes for which the result of the calculation exceeds the clearing thresholds.
The MFSA also reminds counterparties that they are to immediately notify it in the following situations:
- If they decide not to calculate their positions against the clearing thresholds;
- When the result of the calculation exceeds the clearing threshold;
- When they no longer exceed the clearing thresholds.
The MFSA also notes that during its inspections, the main issue related to the counterparties’ failure to provide the clearing threshold calculation in accordance with EMIR Refit. As a result, such counterparties were not able to confirm their classification for the purposes of EMIR.
Classification: Financial Counterparties
From the compliance inspections held by the MFSA it resulted that certain Alternative Investment Funds (“AIFs”) have encountered difficulties in interpreting whether they are to be classified as an FC in terms of EMIR Refit. The MFSA noted that an AIF would be considered a FC either if it is managed by an alternative investment fund manager (“AIFM”) authorised under the Alternative Investment Fund Managers Directive or if the AIF is established in the EU regardless of the location or status of its manager.
Additionally, non-EU AIFs with non-EU AIFMs will be reclassified as third country entities that would be FCs. This means that, on an indirect basis, these entities will be subject to the margin requirements when trading with EU dealers.
Under EMIR, a counterparty which is subject to a reporting obligation may delegate that reporting obligation to another counterparty. Following EMIR Refit, FCs are legally liable for the timely and accurate reporting of OTC derivative contracts on behalf of both themselves and the NFC counterparties.
With regards to funds, EMIR Refit has also shifted the responsibility for reporting the details of OTC derivative contracts entered by a fund to its UCITS management company or AIFM, as applicable. Therefore, a fund will remain responsible and legally liable for reporting details of derivative contracts executed on its behalf on an EU regulated market or a third country market considered as equivalent to an EU regulated market. On the other hand, the fund manager is responsible for reporting details of all other derivative contracts executed on behalf of the fund.
The MFSA observed that counterparties were not fully aware of the abovementioned changes brought about by the EMIR Refit and that a number of delegation agreements were not in place, or if in place, were lacking some fundamental element such as the signatures of the parties. The MFSA is therefore suggesting that counterparties should look into the applicable requirements and have proper delegation agreements in place, where applicable.
Risk Mitigation Techniques
From the inspections conducted, the MFSA has pleasantly noted that the majority of counterparties have sought to satisfy the requirements relating to risk mitigation techniques. However, the authority noted that a number of counterparties did not have the required documentation in place relating to the risk mitigation techniques applied by the relevant entity, even though these mitigation techniques were being applied in practice.
On the other hand, entities who hold documentation, have either implemented tailor-made bilateral agreements with their counterparts, or chose to enter into standard master agreements such as an ISDA agreement. The MFSA notes that where entities make use of such agreements, they are to ensure that all the risk mitigation requirements under EMIR are satisfied. Moreover, where a master agreement was entered into prior to the coming into force of EMIR, the counterparties are to ensure that the agreement is compliant with EMIR’s requirements and if it is not, it is to be updated through a supplementing agreement.
The MFSA also noted that a number of counterparties did not have in place a set of written procedures establishing the process undertaken by the entity to be compliance with the relevant requirements emanating from EMIR. Consequently, the MFSA is recommending that all relevant counterparties should have detailed written procedures ensuring compliance with EMIR.
Feel free to contact us should you require any further information in complying with EMIR or EMIR Refit.