As part of the G20 commitment to lower systemic, counterparty, and operational risk and improve transparency in the OTC derivatives market, the European Union (EU) launched EMIR.
Additionally, it aimed to safeguard against the consequences of potential future financial crises, similar to the 2008 collapse that followed Lehman Brothers’ bankruptcy.
Trade repositories compile and preserve all trade records. Central counterparties mediate between contracting parties and serve as the focal point of each transaction.
Entities report all derivatives, whether over-the-counter or exchange-traded, to a trade repository under EMIR.
EMIR covers companies eligible for derivative contracts, including interest rate, equity, foreign exchange, credit, and commodity derivatives.
The European Markets Infrastructure Regulation (EMIR) aims to increase transparency and reduce systemic risks in the over-the-counter (OTC) derivatives market.
In This Post
Objectives of European Markets Infrastructure Regulation (EMIR)
The following are the objective of EMIR:
Clearing
When a central counterparty assumes a contract under EMIR, the European Securities and Markets Authority (ESMA) enforces mandatory clearing obligations for certain OTC derivative contracts.
Central counterparties clear over-the-counter derivatives transactions to meet the obligations. EMIR temporarily exempted pension funds from these rules until August 2017. During a review of the regulation, authorities further extended the exemption until June 18, 2021.
All trade participants must promptly notify each other when they approach, exceed, or fall below the EMIR-defined clearing threshold.
Both financial and on-financial counterparties, including banks, insurers, and asset managers, are subject to this clearing regulation.
Reporting
Entities that enter into derivative contracts must report each over-the-counter transaction to the relevant trade repository under EMIR.
Entities must include the legal entity identification (LEI), unique transaction identification (UTI), counterparty trading ability information, and the position’s marked-to-market valuation when submitting reports.
The counterparty data in a report includes 26 fields for data and the common data includes 59 fields of data.
Based on the report’s LEI, these fields include the unique trade identifier and an LEI, which is a 20-digit alphanumeric code that can be used for eight of the 26 counterparty data fields.
The fund manager must be notified of block trades, which are large-scale share transactions, and any subsequent allocations; however, block trades carried out by a TR are exempt from this requirement.
On the trade date, only the allocations must be reported if the block trade is allocated to the manager’s personal funds.
It is necessary to report the block itself to the fund manager as a counterparty if the block trade is not allocated on the trade date.
Risk mitigation
The management and prevention of systemic risk is one of EMIR’s main goals. In order to lower systemic risk, EMIR and similar laws restrict clearing and trading, which lowers returns and industry efforts.
The risk mitigation regime under EMIR is applicable to both over-the-counter derivative contracts involving third country entities and contracts involving both EU countries.
Since bilateral derivatives are unsuitable for conventional central counterparty clearing, they are subject to risk management regulation under the risk mitigation standards set forth in EMIR’s
Additionally, EMIR cautions against front-loading over-the-counter derivatives or charging sellers exclusively for any associated fees, as these actions usually raise systemic risk.
According to EMIR, other risk mitigation strategies include open reconciliation and portfolio compression amongst participating parties, as well as prompt report submission and confirmation of regulatory compliance by all counterparties.
The public exchange of collateral between parties, daily market reports and exchanges, and a new dispute resolution procedure are additional strategies.
Conclusion
The European Markets Infrastructure Regulation (EMIR) is a crucial regulatory framework ensuring the stability and transparency of derivatives trading in the EU.
Understanding EMIR helps forex traders and financial institutions navigate compliance requirements and mitigate trading risks effectively.
For traders and institutions dealing in forex derivatives, staying compliant with EMIR is essential to avoiding penalties and ensuring smooth trading operations.
Additionally, it lists three sets of responsibilities, such as clearing, reporting, and risk-reduction for relevant products.
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