End to the EMIR charade

As of the middle of last month, to be precise as of the 18th of June, most companies and institutions no longer have to worry about reporting their derivatives to a ‘trade repository’. This regulatory change had been coming for some time. As most of you will know, from 2013/2014 all companies and institutions that entered into financial derivatives (e.g. interest rate swaps or FX forwards) had to deal with EMIR regulations.

A brief refresher

In response to the lack of clarity (read: chaos) that arose during the credit crisis when trying to get a picture of the hundreds of millions of derivatives contracts, especially at financial institutions, new regulations were devised internationally. For European parties, these were included in the so-called EMIR legislation (European Market Infrastructure Regulation). The hallmark of most derivatives entered into by companies is that they are not traded on an exchange but contracted bilaterally. These are called ‘over the counter’ (OTC) instruments. Each OTC instrument was, until then, by definition only on the books of the two parties involved. It was therefore enormously difficult for central banks and other regulators to keep track of who had entered into which derivative and what its economic impact (especially the market value development) was on both parties. In response, it was decided that most derivatives would be tracked in a central register. In that register, both parties then had to report every new transaction. This was a conscious choice, because it reduced the risk of discussion or fraud. Any discrepancies between the two filings of the same transactions would automatically become visible immediately.

Impact

For banks and other major players in the financial markets this was in our view a logical development. What was less logical was that ‘ordinary’ companies with a limited number of derivatives were also caught in the net of this broad obligation. After all, the main issue was to better monitor the large professional market participants. Moreover, since all data points from these derivatives had to be delivered to the central register according to a very bulky and technical template, this would lead to a lot of extra work and layers of control for occasional users of derivatives. 

Solution?

The practical solution found at the time was that the banks with whom the firms had entered into their derivatives, with some reluctance, offered to start mirror-reporting the transaction to the central register also on behalf of the client. To do so, the bank’s customers had to sign a rather one-sided contract with their bank(s) authorizing the bank to report the derivatives entered into on their behalf. In doing so, the customer himself remained largely ultimately responsible for providing the data, the bank was not liable, the bank did not charge for the time being but was allowed to do so later, etc etc. Now this practical solution may have been manageable for companies, but it remained something like a solution to a non-existent problem. After all, the systemic risk associated with derivatives does not occur with ordinary companies. In addition, in terms of validation (4 eyes principle), this solution also completely missed the mark because the reporting to the central registry came twice from the same system.  

Amendment from June 2020

This charade has come to an end with the EMIR-REFIT regulation agreed upon in 2019 and implemented last month. Transactions done by all ordinary companies (‘Non Financial Corporate minus’ or ‘NFC-’ in EMIR terminology) will henceforth be automatically reported by the bank alone. Our customers with derivatives have received a letter in the last few months from their house bank(s) explaining that the bank is now legally obliged to take over this responsibility, unless the customer explicitly objects. This removes the old structure. This does not solve the fact that both reports come from the same system but at least ordinary corporate users of derivatives are hardly bothered by it anymore. 

Is there still work left? 

Not actually, but be sure to request a new LEI code from the Chamber of Commerce every year (your unique derivatives user number) and pass it on to your bank(s) in time. 

In conclusion

Clients continue to have the option to self-report if they prefer to do so, but we cannot think of any reason for most companies to voluntarily take on this obligation. 

In conclusion, it is of course still very important to check (or have checked) the confirmation from the bank very carefully after entering in a derivative and to raise the alarm immediately (within 1 working day) if you think something is not right.    

As an independent advisor, Orchard Finance will be happy to help you with your questions on interest rate and currency hedging and other questions related to your financing.