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ISDA Readies 2013 EMIR NFC Representation Protocol

Later this month, ISDA is set to publish its “ISDA 2013 EMIR NFC Representation Protocol” (the “EMIR Protocol”), the purpose of which is to enable parties to amend ISDA Master Agreements to reflect their status as either:

  • non-financial counterparties to which the clearing obligation applies (NFC+), or
  • non-financial counterparties to which the clearing obligation does not apply (NFC).

Each adherent to the EMIR Protocol is required to make a repeating representation in relation to each transaction as to whether it is an NFC+ or an NFC.  Broadly, if the representation turns out to be incorrect, the procedures detailed below.

If the underlying transaction was eligible for clearing

  • If the deadline for clearing has not passed, the parties must use all reasonable efforts to make such changes to the transaction as will facilitate clearing by the applicable regulatory deadline.  Note that this may involve a party making a “Balancing Payment” to the other party in order to reflect pricing differences (if any) which flow from the change of environment between cleared and non-cleared.  The Balancing Payment can also include ‘costs, legal fees, other out-of-pocket expenses and related charges’ incurred in the negotiation and implementation of any documentation required in order to facilitate clearing;
  • If the deadline for clearing has passed without clearing taking place, the consequences essentially depend on whether the parties have agreed an execution and give-up agreement which deals with the specific reasons why clearing did not occur in the instant case.  If so, that agreement will dictate the consequences which flow from the failure to clear.  If not, an Additional Termination Event, as further detailed below will occur.

If the underlying transaction was not eligible for clearing

  • In these circumstances, the parties should use all reasonable efforts to make such changes to the transaction as are necessary in order to comply with the EMIR risk mitigation regulatory technical standards (the “Risk Mitigation RTS”).  This needs to be accomplished by the later of:
    • a hard deadline – yet to be agreed, but thought to be in the region of 3-10 business days following the date on which both parties became aware of the original misrepresentation, and
    • the end of the grace period applicable to parties that were previously NFC (and therefore not subject to the Risk Mitigation RTS), but have since become NFC+ (and so have now become subject to the Risk Mitigation RTS).
    • If the parties are unable to comply with the Risk Mitigation RTS by the applicable deadline, an Additional Termination Event, as further detailed below, will occur.

If an Additional Termination Event occurs:

  • Any party which made a misrepresentation regarding its status as a non-financial counterparty will be an “Affected Party” for the purposes of the ISDA Master Agreement;
  • Both parties will be “Affected Parties” for the purposes of section 6(b)(iv) of the ISDA Master Agreement;
  • Payments on early termination will be calculated on the assumption that:
    • any Affected Party was NOT subject to the clearing obligation (whether or not this was actually the case); and
    • Loss will apply.

It is worth noting that neither a misrepresentation about NFC status nor a failure to take action to modify a problem transaction will constitute an Event of Default pursuant to the underlying ISDA Master Agreement.  In addition, the failure of a party to take action to modify a problem transaction will not prevent it from being able to designate an Early Termination Date as a result of the occurrence of an Additional Termination Event under the EMIR Protocol.

The drafting of the EMIR Protocol is rather opaque in parts.  In order to help our understanding of the process flow, we created a decision tree which breaks down the events which follow the occurrence of a misrepresention regarding NFC status.  Once the final EMIR Protocol is published we will check that it remains accurate and will happily share it with anyone who is interested.

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