European Market Infrastructure Regulation (EMIR)


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European Market Infrastructure Regulation (EMIR)

  1. 1. Produced By: Kaushik Pramanik, BME, MTech, DFI (LSE), PGDOL(Oxford), PMP, MSP
  2. 2. EMIR stands for “European Market Infrastructure Regulation” European regulation to regulate European Union market place to stabilize OTC Derivatives transactions. The core of EMIR is Electronic or Exchange trading of OTC Derivatives trades, clearing through Central Clearing Party (CCP), Trade repositories, Trade reporting, Monitoring of Credit risk and Operational risk. It is entered into the regulatory force on 16-Dec-2012. The regulation applies to any form of Derivatives transactions. As per G20 leaders commitment in Pittsburgh in September 2009: “All standardized OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest. OTC derivative contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements. We ask the Financial Stability Board and its relevant members to assess regularly implementation and whether it is sufficient to improve transparency in the derivatives markets, mitigate systemic risk, and protect against market abuse.”
  3. 3. Who will be impacted by EMIR ? •The collapse of Lehman Brothers, AIG and Bear Stearns in 2008 exposed the fundamental weaknesses in the regulation of the USD 800 trillion Over-The-Counter (OTC) derivatives market. •Most of the time OTC Derivatives trades are not cleared through Central Counter Parties (CCPs) resulting high credit risk exposure of each parties. •Major percentage of OTC Derivatives trades are not recorded into Trade Repositories, no significant control over live and historical trades. •Operational process of OTC Derivatives trades are not optimal, resulting higher operational risk faced by financial and non-financial firms. Financial and non-Financial firms based in Europe who are involved in any sort of OTC Derivatives transactions. Financial and non-Financial firms based in non-European countries who are involved in any sort of OTC Derivatives transactions with EU counter parties. Note: The exemption applies to “commercial end users,” such as industrial firms, utilities and airlines, which use swaps to counter risk (hedge) in goods they purchase or manufacture and against fluctuations in interest rates.
  4. 4. Example of standard OTC (Over-The-Counter) Derivatives products are Swaps, Forward, Options, and any other “Over- The-Counter” contractual agreement between two parties on the basis of underlying assets. Each of the standard products have different variations as given below Swaps: Interest Rate Swaps, Currency Swaps, Basis Swaps, Equity Swaps, Commodity Swaps, Credit Default Swaps, and other derived structured Swaps. Forward: Forward Rate Agreement Options: Swaptions, FX Options, Interest Rate Options, Employee Stock Options, Real Estate Options and other derived structured options. What are OTC Derivatives products ? OTC Derivatives is “Over - The – Counter” contract between two parties whose value depends on underlying financial instruments like interest rate, FX, Equity, Commodity, Index etc. OTC Derivatives market notional is around USD 800 trillion globally.
  5. 5. Central Counter Party (CCP) is an intermediate legal entity through which financial transactions of contractual parties of derivatives contacts are cleared to reduce individual credit risk. Each party in the transaction enters into a contract with the CCP , so each party does not take on the risk of the other defaulting. In this way, the CCP is essentially involved in two mutually opposing contracts. CCP reduces counterparty risk and strengthens overall market integrity. It also helps with position segregation and portability in the event of a default, improves transparency for regulatory requirements and benefits the central management of trade lifecycle events, such as cash settlement with CCP. What is Central Counter Party (CCP) ? OTC Derivatives electronic trading is a facility, trading system or platform in which multiple participants have the ability to execute or trade derivatives products by accepting “bids & offers” or contracts made by other participants or broker, through any means of interstate commerce therefore allowing increased transparency and provides the tools for a complete trade confirmation and audit. A good example is “Markitwire” platform to execute Swaps, Options and FRAs.
  6. 6. OTC derivative transactions cleared through CCPs forces counterparties to pay (from day one) initial and variation margins in highly liquid collateral (cash, gold, government bonds, etc.). EMIR protects collateral placed with CCPs in the event of insolvency of a clearing member – and from losses from other clients. Collateral Management with CCPs is a complex topic and varies with CCPs in different countries. What is Trade Repository ? A Trade Repository (TR) is regulatory legal entity hat centrally collects and maintains all economics and records of OTC derivatives trades. In the bank an electronic platform (called TR data warehouse) acting as an authoritative registries of key economic information regarding open, closed and cancelled OTC derivatives trades related to a legal entity. Data in the trade repository data warehouse is one of the key source of various EMIR related reporting. What is Variation Margin? Variation margin is paid by clearing members on a daily or intraday basis in order to reduce the exposure created by carrying highly risky positions. By demanding variation margin from its members, clearing organizations are able to maintain a suitable level of risk and cushions against significant devaluations. What is Initial Margin? Initial Margin is the percentage of the purchase price of securities (that can be purchased on margin) that the investor must pay for with his or her own cash or marginable securities.
  7. 7. Electronic Trade Capture Platform Executing Broker Client Bank or Financial Services Central Clearing Party Bank Tarde Risk Management Platform Bank Internal Trade Repositories Voice Confirmation Enters Trade Affirms Trade Affirms Trade Margin & Premium Margin & Premium Bank External Regulatory Reporting (TR) 1 4 5 6 7 8 9 10 Voice Confirmation 2 3
  8. 8. Markitwire MarkitSERV ICE Link for CDS (Credit Default Swaps) Market Axess Tradeweb State Street Market leading OTC Derivatives Central Clearing Platform LCH.Clearnet (LCH: London Clearing House) DTCC ICE Clear for CDS CME Eurex Inter Continental Exchange (ICE) DTCC
  9. 9. Designing, testing and documenting business and operational clearing processes, capability and infrastructure. Designing new management reports to monitor and control confirmation processes, capabilities and infrastructure. Improving processing efficiency and control in relation to EMIR Reviewing and adapting trade capture processes, to gather required transaction reporting data and to develop connectivity with trade repositories. Designing, implementing and testing regulatory, treasury and transaction reporting systems. Develop front to back collateral management solution. New business process and strategy for collateral and liquidity management. Adapting the firms’ operational, credit and market risk strategy in light of EMIR requirements. Involvement of CCPs in all sort of Derivatives products. Valuation of trades including margins and CCP fees. New regulatory reporting structure related to EMIR for TR. Changes in IT landscape to trigger “Straight-Through-Processing” (STP), e-trading, auto- confirmation, reconciliation, CCP interface, reporting data warehouse etc. Involvement of wide business area to identify any sort of OTC Derivatives trading in the bank. Gap analysis and health check tools to measure the readiness of EMIR requirements.
  10. 10. Changes in operational model and process when dealing with OTC Derivatives trades. More focus on centrally cleared rather than bilaterally cleared. Exchange trading will grow by 25-30% in the future. Increased costs and higher capital charges will reshape trading and hedging strategies in a long run. More requirement on high-quality collateral by CCPs. Development of new collateral management business models. Liquidity stresses will increase due to likely short-term gross margin placements at CCPs. Firms have to disclose level of protection including legal implications in case of insolvency, offered to customers by CCPs.
  11. 11. Please contact: Kaushik Pramanik Email: Phone: +41-767174293