The EMIR reporting obligation requires that certain information regarding the execution, modification or termination of any OTC or exchanged traded derivative contract is reported to a trade repository no later than one working day following the relevant event.
The European Securities and Markets Authority (ESMA) recently confirmed that the EMIR reporting obligation will commence on 1 January 2014 with respect to all five asset classes – interest rate products, credit derivatives, foreign exchange, commodities and equity derivatives. Originally it had been the case that the reporting obligation would be implemented as a two-stage process in order to mitigate operational risk and to help ensure that the industry could fully support delegated reporting for end users. Reporting with respect to interest rate products and credit derivatives was due to be introduced first, with reporting for all remaining asset classes following on some months later. The industry has asked for more time to prepare for reporting and requested that the phased approach to implementation be reinstated. However, there currently seems to be little prospect of a change of heart within ESMA. As a consequence, firms need to focus on being ready to meet a 1 January 2014 deadline.
Where to Start
On 19 July 2013, ISDA published the “ISDA 2013 EMIR Portfolio Reconciliation, Dispute Resolution and Disclosure Protocol” together with its “Reporting Guidance Note” (the “RGN”). The RGN constitutes a set of pro-forma clauses designed to assist parties in amending ISDA Master Agreements on a bilateral basis so as to facilitate compliance with EMIR reporting obligations. It is divided into 5 sections, each dealing with a separate issue related to EMIR reporting:
- Reporting Roles;
- Reporting Obligations;
- Remedies for Breach; and
- Correction of Errors.
ISDA has indicated that it does not intend to assist industry compliance with EMIR reporting obligations by way of a protocol. As such, to the extent that market participants intend to document the allocation of responsibilities and other issues associated with EMIR reporting, it will be necessary to do so by way of bilateral amendment to ISDA Master Agreements. To this end, the RGN represents the logical and best place to start.
Despite the assistance provided by the RGN, firms should not underestimate the amount of time and resource required to repaper portfolios of derivative documentation in order to comply with EMIR reporting obligations. In the main, this is a function of the amount of optionality contained within the template clauses constituting the RGN which potentially increases the amount of negotiation with each individual counterparty. By way of example, the final form of the clause provided within the “Reporting Roles” section of the RGN will depend on the ultimate agreement reached between counterparties with respect to a number of issues, including:
- the identity or identities of the reporting parties;
- whether a reporting party will report “counterparty data” and/or “common data”;
- whether certain information (relating to mark-to-market valuations, mark-to-model valuations and collateral) is not to be reported by a reporting party; and
- whether reporting will be delegated to a third party.
In theory at least, there are well over 200 discrete clauses that are required in order to fully document all possible permutations flowing out of the “Reporting Roles” section alone. Fortunately, in reality, it seems likely that the majority of amendments can be executed on the basis of a much smaller set of template clauses. In addition, the remaining sections of the RGN contain little or no additional optionality. Nonetheless, the size of the task at hand, and the need to carefully plan an approach to amending documentation, become apparent.
Adopting the Correct Approach
The creation of a streamlined process formulated with clearly defined goals in mind is key to the successful and efficient amendment of large portfolios of documentation. A number of elements define this process, as detailed below.
A significant amount of pre-preparation will be required for any firm using the RGN as a basis for amending its legacy derivative documentation. As a first step, the answers to a number of questions will have to be determined internally, including:
- Will the firm report OTC derivative transactions on behalf of its clients?
- If so, will the firm report all of the counterparty’s trades (irrespective of the identity of the other party to the trade), or only those trades executed with the firm?
- Will transactions be reported directly or through a third party?
- With respect to all of the above questions, is it only common data that is to be reported, only counterparty data, or both?
Once the answers to these questions are known, the firm should create a set of internal guidelines documenting its policy and position with respect to the various aspects of EMIR reporting. These guidelines can then be used to drive the creation of template documentation. An education piece, describing the background to the amendment agreement and its purpose, supported by a short programme of internal staff training, will also be invaluable in streamlining the negotiation phase. Firms should also give some thought to the designing of a process to monitor and chase client responses, handle exceptions, update internal systems and feed back ‘lessons learned’ into internal processes. Last, but by no means least, firms will have to acquire (and validate) appropriate static data in advance of a client outreach phase. Some of this information, such as client address details, should be readily available from internal systems. Others, such as details of the clause number of the ISDA Master Agreement in which the amendment will be inserted, may be slightly less easy to acquire and may require inspection of underlying documentation.
Initial Client Outreach
Given the amount of optionality within the RGN, firms may also want to consider conducting an initial client outreach prior to the actual dispatch of amendment documentation. The purpose of this outreach would be to understand the requirements of clients and to determine how they tally with the pre-defined positions of the firm with respect to transaction reporting. In turn, this would inform the drafting of specific documentation, tailored to the needs of individual clients, and would also identify outlier clients which may have to be dealt with on an ad hoc basis. In doing so, the aggregate effort associated with negotiation would be reduced to the extent possible. Technology exists which can further assist in accomplishing this type of targeted outreach.
Whilst any negotiation phase will be relatively labour intensive, efforts in the pre-negotiation phase will have a significant impact on the amount of resource required as well as ultimate success. In particular, carefully designed template documentation and a clear set of guidelines regarding the handling of queries and exceptions is key. In addition, internal protocols must recognise that the negotiation process is iterative, in the sense that a mechanism must exist to ensure that ‘lessons learned’ inform future negotiations.
In order to exercise continued control over a project of this type, a robust set of processes must exist for monitoring responses, reporting on progress and dealing with exceptions. Moreover, the project does not end at the point at which agreement with a counterparty is reached. Rather, further procedures must exist which ensure the timely and accurate updating of internal systems and the storage of executed documentation.
 EMIR, Article 9