European Market Infrastructure Regulation: Explained | TIOmarkets
BY TIO Staff
|July 5, 2024The European Market Infrastructure Regulation (EMIR) is a body of European legislation for the regulation of over-the-counter derivatives. It was introduced in 2012 as a response to the 2008 financial crisis and is a crucial part of the European Union's financial reform agenda. EMIR aims to increase transparency and reduce the risks associated with the derivatives market.
EMIR has a broad scope, affecting a wide range of entities, from financial institutions to corporates, pension funds, and even individuals. It applies to any entity that enters into any form of derivative contract, including those not involved in financial services. This article will delve into the intricacies of EMIR, providing a comprehensive understanding of its objectives, requirements, and impacts on the trading industry.
Background of EMIR
The 2008 financial crisis highlighted the systemic risk posed by the derivatives market, which was largely unregulated at the time. In response, the G20 leaders agreed in 2009 that all standardised over-the-counter (OTC) derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties (CCPs).
EMIR was introduced by the European Union in 2012 to implement the G20 commitment within its jurisdiction. The regulation aims to increase transparency in the derivatives market, reduce the risk of counterparty default, and protect against market abuse.
Key Objectives of EMIR
EMIR has three main objectives: to increase transparency, to reduce counterparty credit risk, and to reduce operational risk in the derivatives market. To achieve these objectives, EMIR introduces several requirements, including the mandatory clearing of certain classes of OTC derivatives, the reporting of derivative contracts to Trade Repositories, and the application of risk mitigation techniques for non-cleared OTC derivatives.
By increasing transparency and reducing risk, EMIR aims to make the derivatives market safer and more efficient. It also seeks to ensure that non-financial firms, which were not previously subject to such regulation, are now included in the regulatory framework, thereby increasing the scope of financial regulation in the EU.
Legislative Process of EMIR
The legislative process of EMIR involved several stages, including the proposal by the European Commission, the adoption by the European Parliament and the Council, and the implementation and enforcement by the European Securities and Markets Authority (ESMA) and national competent authorities.
EMIR is directly applicable in all EU Member States, which means that it does not need to be transposed into national law by the Member States. However, certain aspects of EMIR, such as the technical standards, are subject to the comitology procedure, which involves further scrutiny by the European Parliament and the Council.
Key Requirements of EMIR
EMIR introduces several key requirements for entities involved in the derivatives market. These requirements aim to increase transparency and reduce risk in the derivatives market.
The main requirements of EMIR include the clearing obligation, the reporting obligation, the risk mitigation techniques for non-cleared OTC derivatives, and the requirements for CCPs and Trade Repositories.
Clearing Obligation
The clearing obligation under EMIR requires certain classes of OTC derivatives to be cleared through a CCP. This means that the CCP becomes the counterparty to both parties in the contract, thereby reducing the counterparty credit risk.
The clearing obligation applies to EU firms that are financial counterparties (FCs) or non-financial counterparties above the clearing threshold (NFC+). The specific classes of OTC derivatives subject to the clearing obligation are determined by ESMA, based on the liquidity of the market and the availability of fair, reliable, and generally accepted pricing in the market.
Reporting Obligation
The reporting obligation under EMIR requires all derivative contracts to be reported to a Trade Repository. This includes OTC derivatives and exchange-traded derivatives (ETDs).
The reporting obligation applies to both parties to the contract, although they can delegate the reporting to a third party. The reports must include details of the contract, any modifications, and the termination of the contract. The aim of the reporting obligation is to increase transparency in the derivatives market and to provide regulators with information to monitor and address systemic risk.
Impact of EMIR on Trading
EMIR has a significant impact on the trading industry, particularly for firms involved in the derivatives market. The regulation introduces new requirements and obligations that firms must comply with, which can involve significant changes to their operations and systems.
However, EMIR also provides opportunities for firms to improve their risk management and to benefit from a safer and more transparent derivatives market. For example, the clearing obligation can reduce counterparty credit risk, while the reporting obligation can provide firms with valuable data for risk management and decision-making.
Challenges for Firms
One of the main challenges for firms under EMIR is the compliance with the new requirements and obligations. This can involve significant changes to their operations and systems, such as the implementation of new processes for clearing and reporting, the establishment of collateral arrangements for non-cleared OTC derivatives, and the adaptation to the new regulatory framework for CCPs and Trade Repositories.
Another challenge for firms is the increased costs associated with the compliance with EMIR. These costs can include the direct costs of clearing and reporting, the indirect costs of collateral and capital requirements, and the operational costs of implementing and maintaining the necessary systems and processes.
Opportunities for Firms
Despite the challenges, EMIR also provides opportunities for firms. The regulation aims to make the derivatives market safer and more transparent, which can benefit firms in several ways.
For example, the clearing obligation can reduce counterparty credit risk, which can improve the stability and resilience of firms. The reporting obligation can provide firms with valuable data for risk management and decision-making. Furthermore, the increased transparency and regulation in the derivatives market can increase investor confidence and attract more participants to the market.
Conclusion
EMIR is a crucial part of the European Union's financial reform agenda, aiming to increase transparency and reduce the risks associated with the derivatives market. While the regulation introduces new requirements and obligations for firms, it also provides opportunities for firms to improve their risk management and to benefit from a safer and more transparent derivatives market.
Understanding EMIR is essential for any entity involved in the derivatives market, as it affects a wide range of entities and has a significant impact on the trading industry. This article has provided a comprehensive understanding of EMIR, including its background, objectives, requirements, and impacts on trading.
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