If you regularly enter into options, futures, forwards, interest swaps, currency swaps or any other form of derivatives, this article will definitely be of interest to you. Derivative transactions have been largely blamed as being one of the main ingredients causing the financial crisis which characterised the past decade. As a result of this perception, the wave of regulation at an EU level could not spare derivatives and this resulted in Regulation (EU) No 648/2012 on OTC derivative, central counterparties and trade repositories, commonly referred to as EMIR.

The difference between this and other recent EU legislation is that whereas most of the other legislative initiatives has focused on regulating entities, EMIR has focused much more on regulating the activity. This dispels a common misconception that EMIR affects only credit institutions, funds, insurance entities and other regulated entities. EMIR, to varying extents, affects all parties to OTC derivatives. Naturally the obligations imposed on financial institutions are much more onerous since they are deemed to represent a larger systemic risk.

In order to determine the precise obligations per counterparty it is important to understand in which category it should be class-ified. EMIR sets out three main categories:

FCs, financial institutions includes credit institutions, investment firms, UCITS, insurance and reinsurance undertaking and alternative investment funds managed by alternative investment fund managers;

Whereas most of the other legislative initiatives has focused on regulating entities, EMIR has focused much more on regulatingthe activity

NFC+s, non-financial institutions which exceed certain clearing thresholds as set out in EMIR; and

NFC-s, non-financial institutions which are below the clearing thresholds and are therefore subject to less onerous requirements than FCs and NFC+s.

Since EMIR will represent a revolution in the way the world of derivatives operates, its implementation has been staggered in various stages over a number of years. To date the most relevant provisions for Maltese entities trading in derivatives are set out in Commission Delegation Regulation (EU) No. 149/2013 of December 19, 2012, which came into force on March 15, 2013 setting out technical standards (the “Technical Standards”) on a number of derivative-related obligations, including the obligation to utilise prescribed risk mitigation techniques.

The risk mitigation techniques can be classified into the following categories:

• timely confirmation

• portfolio reconciliation

• portfolio compression

• dispute resolution.

The obligation to confirm trades as soon as possible has been in force since March 15, 2013. The remaining obligations came into force on September 15, 2013.

Portfolio Reconciliation

Financial and non-financial counterparties entering into an OTC derivative contract must, before entering into the contract, agree in writing or other equi-valent electronic means the arrangements under which the portfolio shall be reconciled to ensure that both parties will utilise the same methodology.

The reconciliation requirements vary between FCs, NFC+s and NFC-s.

Portfolio compression

FCs and NFCs with 500 or more OTC derivative contracts outstanding with a counterparty are obliged to have in place procedures to regularly (and at least bi-annually) analyse the poss-ibility to conduct a portfolio compression exercise in order to reduce their counterparty credit risk and, where possible, to engage in such a portfolio compression exercise.

Dispute Resolution

In terms of the technical standards, FCs and NFCs have an obligation to agreed detailed procedures and processes in relation to:

the identification, recording and monitoring of disputes relating to the recognition or valuation of the contract and to the exchange of collateral between counterparties. The procedures are required to record the length of time for which the dispute remains outstanding, the identity of the counterparty and the disputed amount;

resolve dispute in a timely manner (with a specific process for those disputes that are not resolved within five business days).

September 15 is one of many dates which will be relevant in the implementation of EMIR. It is important that all participants in the OTC derivatives market keep an eye on key dates.

Whether you are a utility company, a bank, an importer with exposure to currency risk, an airline trying to hedge your fuel costs or a trading entity trying to fix your interest rates, it is time to familiarise yourself with the requirement to ensure compliance with EMIR.

Leonard Bonello is an associate with Ganado Advocates.

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