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ESMA Publishes RTS for Non-EU OTC Derivatives

Introduction

On 18 November 2013, the European Securities and Markets Authority (ESMA) issued final draft regulatory technical standards (RTS) under EMIR regarding OTC derivative transactions entered into by non-EU counterparties:

  • which have a “direct, substantial and foreseeable effect” with the EU, and
  • where it is necessary or appropriate to prevent the evasion of any provision of EMIR.

EMIR states that, if an OTC derivative contract has a “direct, substantial and foreseeable effect” within the EU, then:

  • any two entities established in one or more third countries (“Third Country Entities”) that would be subject to the clearing obligation if they were established in the EU shall be subject to the obligation to clear under EMIR[1]; and
  • EMIR risk mitigation techniques shall apply to OTC derivatives between Third Country Entities that would be subject to those obligations if they were established in the EU[2].

 “Direct, Substantial and Foreseeable Effect”

The RTS will only apply to OTC derivative contracts entered into by Third Country Entities from jurisdictions for which the EU Commission has not declared regulatory equivalence[3].  Such transactions will be considered as having a “direct, substantial and foreseeable effect” within the EU where one of the following conditions are met:

  • one of the Third Country Entities is guaranteed by an EU financial entity for:
    • a total gross notional amount of at least EUR 8 billion or the equivalent amount in a relevant foreign currency (or a proportion of this amount when the guarantee covers a percentage of the liability resulting from the OTC derivative contract), and
    • an amount equal to or greater than 5% of the OTC derivatives exposures of the EU financial guarantor (the “Quantitative Thresholds”); or
  • the two Third Country Entities execute the relevant transaction via EU branches and would qualify as financial counterparties if established in the EU.

The Quantitative Thresholds

All outstanding contracts should be considered in calculating both Quantitative Thresholds, even if concluded before the date of application of the RTS or before the execution of the relevant guarantee.  The EUR 8 billion Quantitative Threshold is calculated on a gross basis and by reference to the guarantees issued by a single guarantor, rather than on a consolidated basis.  Furthermore, where the liability resulting from one or more OTC derivative contracts is below the EUR 8 billion Quantitative Threshold, such contracts shall not have a direct, substantial and foreseeable effect within the EU even where the maximum amount of the relevant guarantee is equal to or greater than the EUR 8 billion Quantitative Threshold and even in circumstances where the 5% condition has been satisfied.  Periodic monitoring of the Quantitative Thresholds is required:

  • where the guarantee itself is for an amount below EUR 8 billion: on any day on which the amount of the guarantee is increased; and
  • where the amount of the guarantee is above 8 billion, but the liabilities resulting from the OTC derivatives contracts covered by the guarantee are below 8bn or 5%: on any day on which the liability for the EUR 8 billion threshold is increased and monthly with respect to any decrease of the sum of current exposures for the 5% threshold.

Non-evasion clause

There is no automatic assumption of evasion of the requirements of EMIR under the RTS.  Rather each factual circumstance must be considered on its own merits.  However, the draft RTS state that an OTC derivative contract shall be deemed to have been designed to circumvent EMIR if the way in which that contract has been concluded is considered, when viewed as a whole and having regard to all the circumstances, to have as its primary purpose EMIR avoidance.  This would be the case if the primary purpose of arrangements related to the OTC derivative contract is to defeat the object, spirit and purpose of any provision of EMIR that would otherwise apply.  It would include an arrangement that intrinsically lacks business rationale, commercial substance or relevant economic justification or is structured in such a way as to circumvent the clearing obligation and risk mitigation provisions.

Next Steps and Entry Into Force

ESMA’s draft RTS were submitted for endorsement to the EU Commission on 15 November 2013.  The Commission has three months to decide whether to endorse the final draft RTS and, if so, must then submit the endorsed RTS to the EU Parliament and the EU Council.  The RTS themselves will enter into force on the 20th day following publication in the Official Journal of the EU and will take effect six months after that date.

 


[1] Article 4

[2] Article 11(12)

[3] In accordance with Article 13(2) of EMIR

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