ESMA has updated its EMIR Implementation Q&A suite. Questions and Answers, rather than quality and assurance; the eighth Q&A covers the following areas:
- CCP organisational requirements, account segregation and portability
- Intra-group exemptions
- Treatment of non-exempt, non-EU central banks
- EMIR’s application to Alternative Investment Funds
The questions are drawn from a cross-section of the public, market participants and competent national authorities. The answers are intended to ensure harmony of approach in the implementation of EMIR’s details. While the ESMA Q&A’s are a useful resource, the European ideal of “harmonisation” often seems to be achieved by the fiat imposition of a univocal interpretation with no recourse to appeal. This particular set of updates is specialist; for those who have a particular interest in the above, the full text of the updates is excerpted below:
Article 26 of EMIR – Organisational requirements:
b) Pursuant to Article 3(2) of RTS 153/2013, a CCP shall not share its staff with other group entities, unless under the terms of an outsourcing arrangement in accordance with Article 35 of EMIR. Does the term “staff” extend to the senior management of the CCP (for example the chief executive officer of the CCP) or is it limited to those individuals with clerical or administrative roles?
b) In line with other European legislation, the term “staff” encompasses any person working for the CCP who is directly engaged in the services or activities which the CCP is authorised to provide or perform, and any natural person directly managing or supervising such persons. In particular, the Chief Executive Officer, although being a member of the board, is directly managing the CCP and therefore the provisions applicable to the staff should apply to the Chief Executive Officer.
Where a CCP maintains a two-tiered board system, the term “staff” does not encompass the members of the supervisory board.
Article 39 of EMIR – Segregation and portability:
(m) Can a participant of a trading venue which is also a clearing member of the relevant CCP deny its clients the protections established under Article 39 of EMIR where it exe-cutes trades on behalf of its clients and subsequently clears those trades with the relevant CCP?
(m) No, even if the client does not have an explicit contractual relationship covering the clearing of these trades. Article 2(1)(15) of EMIR provides that a ‘client’ is “an undertaking with a contractual relation-ship with a clearing member of a CCP which enables that undertaking to clear its transactions with that CCP”. Given that the trade is cleared by a CCP, then the contractual relationship entered into by the client enables the clearing of the transaction with the CCP. Therefore, even if the contractual arrangement governing the provision of trading services does not explicitly cover the provision of clearing services by the firm executing the trade on behalf of its client, the latter should be considered a client under EMIR and should benefit from the client protections established therein.
Article 28 of EMIR – Risk Committee
Pursuant to Article 28(1) of EMIR, a CCP shall establish a risk committee, which shall be composed of representatives of its clearing members, independent members of the board, and representatives of its clients. Employees of the CCP, external independent experts and employees of competent authorities may attend in a non-voting capacity. None of the groups of representatives shall have a majority in the risk committee.
a) Is it possible for representatives of other interests (for example trading venues served by the CCP) to be members of the risk committee?
b) How broadly must an individual represent the interests of the CCP’s clients in order to qualify as a representative of such clients on the risk committee?
a) The membership of the risk committee is prescribed in EMIR. An individual cannot be a member of the risk committee where they are neither a representative of the CCP’s clearing members, an independent member of the board, or a representative of the CCP’s clients. Such an individual might, however, be invited to attend risk committee meetings in a non-voting capacity.
b) It is recalled in Recital 61 of EMIR that clients need to be adequately represented on the risk committee as decisions taken by the CCP may have an impact on them. A CCP therefore needs to ensure that the individuals appointed to the risk committee to represent the CCP’s clients are sufficiently representative of the interests of the clients of the CCP. For example, the CCP should have balanced client representation on its risk committee in respect of the activities or services for which the CCP is authorised to provide or perform. Furthermore, the CCP should satisfy itself that the individuals appointed to the risk committee are not conflicted by other interests. For example, a CCP would need to take particular care where an individual appointed to the risk committee to represent the CCP’s clients is from an entity which is in the same group as a clearing member of the CCP.
Guideline and Recommendation 3(b)(v) – Prudential Requirements
Pursuant to Guideline and Recommendation 3(b)(v) of the ESMA Guidelines and Recommendations for establishing consistent, efficient and effective assessments of interoperability arrangements, interoperable CCPs are not allowed to contribute to each other’s default funds or other financial resources (as such are defined in Article 43 of EMIR). However, Guideline and Recommendation 3(b)(iii) provides that CCPs should assess, collect or have access to, the required inter-CCP resources necessary to cover credit and liquidity risk arising from the interoperable arrangement, including in extreme but plausible market conditions.
How should a CCP meet Guideline and Recommendation 3(b)(iii) in the absence of requiring the interoperable CCPs to contribute to its default fund or other financial resources given that a CCP’s default fund and other financial resources (as opposed to the margins it collects) are the means through which the CCP ensures that its financial resources are sufficient to cover extreme but plausible market conditions?
On the basis that interoperable CCPs are not allowed to contribute to each other’s default funds or other financial resources, it is not necessary that a CCP will include its credit exposures to the interoperable CCPs when sizing the default fund and other financial resources (i.e. the default fund of a CCP and the other financial resources are not required to enable the CCP to withstand the default of the interoperable CCPs under extreme but plausible market conditions where the CCP’s exposures to those interoperable CCPs are greater than the CCP’s exposures to the two clearing members to which it has the largest exposures in under extreme but plausible market conditions).
However, where the CCP does not include its credit exposures to the interoperable CCPs when sizing the default fund and other financial resources then it will need to have other arrangements (such as additional margin) in place in order to meet Guideline and Recommendation 3(b)(i) which requires that financial risks, including custody risks, arising from the interoperability arrangement are identified, monitored, assessed and mitigated with the same rigour as the CCP’s exposures arising from its clearing members.
Article 3, 4(2) and 11(6) to 11(10) of EMIR – Intragroup transaction
(e) May a contract between a Financial Counterparty (FC) and another counterparty be eligible for an intragroup exemption if:
- the FC belongs to both a group of undertakings referred to in Article 3(1) or Article 80(7) and (8) of Directive 2006/48/EC (CRD), and another group referred to in Articles 1 and 2 of Directive 83/349/EEC, and
- the other counterparty merely belongs to the group under Articles 1 and 2 of Directive 83/349/EEC
(e) Yes. In accordance with the definition of ‘group’ in Article 2(16), as well as Article 3(2)(d) of EMIR, such contract may be eligible for an intragroup exemption if the other counterparty, while not consolidated under the CRD, is part of the same consolidated non-financial group as the FC.
Classification of non-EU Central Banks
In which EMIR counterparty category does a non-EU central bank fall?
If a non-EU central bank is listed in Article 1(4) of EMIR (as amended by the European Commission from time to time pursuant to Article 1(6) of EMIR), it is exempt from EMIR. For the purpose of the clearing obligation and risk mitigation techniques other than exchange of collateral, if a non-EU central bank is not listed in Article 1(4) of EMIR (as amended by the European Commission from time to time pursuant to Article 1(6) of EMIR), it is to be treated under EMIR as a third country entity that would be an NFC if it were established in the EU.
(c) Should an umbrella fund that is a UCITS or an AIF be considered as the counterparty to a derivative transaction in the context of EMIR, or should the sub-funds thereof be considered as the counterparties?
If the derivative contract is concluded at the level of the sub-fund, the counterparty should be the sub-fund and not the umbrella fund. In that case, the sub-fund needs to have an LEI for reporting purposes and be identified as the counterparty.
Otherwise, the umbrella fund should have an LEI for reporting purposes and be identified as the counterparty. The sub fund should be identified as the beneficiary.
Status of counterparties covered by AIFMD
What is the status of the following counterparties under EMIR?
i. EU AIFs and non-EU AIFs referred to in Article 61(3) of AIFMD (i.e. closed-ended AIFs that do not make any investments after 22 July 2013) and in Article 61(4) of AIFMD (i.e. closed-ended AIFs whose subscription
period had closed prior to entry into force of AIFMD) that are managed by AIFMs that are exempt from authorisation due to the provisions of Article 61(3) and (4).
ii. AIFs referred to in Article 61(3) of AIFMD (i.e. closed-ended AIFs that do not make any investments after 22 July 2013) and in Article 61(4) of AIFMD (i.e. closed-ended AIFs whose subscription period had closed prior to entry into force of AIFMD) that are managed by AIFMs authorised or registered under AIFMD because they also manage other types of AIF.
iii. Securitisation special purpose entities referred to in Article 2(3)(g) of AIFMD.
iv. Special purpose vehicle (SPVs) created by real estate and private equity AIFs.
i. These EU AIFs should be classified as non-financial counterparties and these non-EU AIFs should be classified as third country entities.
ii. These AIFs should be classified as financial counterparties. Under Article 2(8) of EMIR, the definition of a financial counterparty includes “an alternative investment fund managed by AIFMs authorised or registered in accordance with Directive 2011/61/EU”. Therefore, if a fund is an AIF and is under the management of an authorised or registered AIFM, then it falls within the scope of EMIR as a financial counterparty.
iii. AIFMD does not apply to the entities listed in Article 2(3) of this Directive, hence “securitisation special purpose entities” referred to in Article 2(3)(g) of AIFMD should not be considered as “AIFs managed by AIFMs authorised or registered in accordance with AIFMD”. Therefore, they do not meet the definition of financial counterparties and should be considered as non-financial counter-parties (NFCs) for the purpose of EMIR.
iv. AIFs may hold 100% of the shares of SPVs, whose purpose is to purchase, hold or administrate undertakings. This type of structure is particular common for private equity AIFs and real estate AIFs. The OTC derivative contracts concluded for the activity of the AIFs are concluded at the lev-el of these SPVs. SPVs are non-financial counterparties under EMIR if they do not meet the crite-ria set out in the definition of financial counterparty under Article 2(8) of EMIR. Those SPVs need to comply with the rules and obligations for non-financial counterparties under EMIR.
Authorised or registered AIFMs [last update 21 May 2014]
The definition of a financial counterparty provided in Article 2(8) of EMIR includes AIFs which are managed by authorised or registered AIFMs. Which entities does the definition exactly cover?
The definition of a financial counterparty should be understood as covering the following entities:
1. EU AIFs managed by authorised EU AIFMs.
2. EU AIFs managed by registered EU AIFMs.
3. Non-EU AIFs managed by authorised EU AIFMs.
4. Non-EU AIFs managed by registered EU AIFMs.
5. EU AIFs managed by authorised non-EU AIFMs
(subject to extension of the passport).
6. Non-EU AIFs managed by authorised non-EU AIFMs (subject to extension of the passport).
Non-EU AIFs marketed in the Union by non-EU AIFMs (both below and above the thresholds of Article 3(2) of the AIFMD) under Article 42 of the AIFMD should be considered as third-country entities because they are neither undertakings established in the Union nor are they managed by authorised or registered AIFMs. EU AIFs marketed in the Union without a passport by non-EU AIFMs (both below and above the thresholds of Article 3(2) of the AIFMD) under Article 42 of the AIFMD should be considered as non-financial counterparties because they are undertakings established in the Union and they are not managed by authorised or registered AIFMs.