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The Extraterrestrial nature of the Extraterritoriality rules

The final Delegated Regulation on the extra-territorial application of EMIR (Commission Delegated Regulation (EU) No 285/2014) came into force on 10 April 2014 with a separate deadline of 10 October 2014 to tackle derivatives contracts that are considered to have a “direct, substantial and foreseeable effect” within the EU (Article 2).  ESMA’s intention was to allow third country entities (TCEs) more time to prepare for compliance.  Despite the six month extension, dealers continue to find the regime impossible to implement due to its uncertain nature.   The imprecise treatment of Article 2 was raised by market participants in the Final Draft RTS (ESMA/2013/1657) with questions left unanswered in the final text and no further guidance issued to date.

The overall application of Article 2 has proved difficult. When two counterparties are established in third countries, the clearing obligation under Article 4(4) and the risk mitigation techniques under Article 11(12) of EMIR (Regulation (EU) No 648/2012 of the European Parliament and of the Council) apply under two conditions:

  • transactions having a “direct, substantial and foreseeable effect in the Union” (Article 2), or
  • transactions conducted under arrangements designed to evade EMIR rules (Article 3).

Both conditions are subject to equivalence assessments set out in Article 13 which ESMA has yet to finalise in respect of third country regimes. Article 13 states the need to avoid duplicative or conflicting rules in third country jurisdictions by substituting EMIR compliance for equivalent third country requirements.

More specifically, there have been problems with the particular language used to describe the two types of OTC derivatives contracts which will have a “direct, substantial and foreseeable effect” in the EU:

  • Contracts between TCEs where at least one TCE benefits from a guarantee by an FC established in the EU over certain cumulative thresholds – a least 8 billion euro equivalent for an aggregated notional amount or 5 percent of the sum of the current exposures, or
  • Contracts between EU branches of TCEs where the TCEs would qualify as FCs if established in the EU.

The extra-territoriality provisions do not clarify the meaning of “established in the Union” which causes some uncertainty as to which FC guarantor entities are within scope. Market participants are also unclear as to whether the guarantees are to be measured on a single or an aggregate-guarantee basis.

ESMA has recognised the importance in the consistent implementation of the extra-territoriality rules but a continued lack of clarity in its interpretation will only result in regulatory fragmentation if ESMA continues to delay.

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