EMIR - If you think it’s not for you, think again
Initially published on AGEFI
The turbulence on the energy markets and the recent collapse of the Silicon Valley Bank have reminded many of the effects of the last financial crisis in 2008 when capital markets experienced extreme volatility. The response of the European Union in the aftermath of that crisis was a wide range of regulatory initiatives which were developed to strengthen the European capital markets. One of the key regulatory initiatives was the European Market Infrastructure Regulation (EMIR).
The regulation came into force in 2012 with the goal to reduce the systemic risk and increase the transparency of the derivatives markets in the European Union. Consequently, financial and even non-financial counterparties (including banks, investment funds, insurance companies) to derivatives trades1 had, among other requirements, to report each derivative trade to a trade repository; the reported data being accessible by both the European and the national competent authorities.
The CSSF has sent over 100 observation letters to banks established in Luxembourg
However, despite being in force for over a decade now, the regulation still hasn’t been fully complied with by all the entities in scope. The biggest challenges for them are the extent of the requirements as well as the split roles of the actors in the derivatives settlement chain. Also, EMIR has been amended several times over the past years (e.g. EMIR REFIT), so that even those parties that were fully compliant at the initial entry into force of the regulation, face compliance gaps if they haven’t transposed the latest updates.
As a response, both national and European regulators have invested significant efforts to enforce the correct application of EMIR across the European Union. Multiple quality reviews have been performed by the authorities, often resulting in warnings or even fines. The Luxembourg Financial Sector Supervisory Commission (CSSF) for instance has sent over 100 observation letters to banks established in Luxembourg highlighting identified deficiencies in relation to EMIR. In 2016, a law was voted in Luxembourg which enables the competent authorities to issue fines up to 1.5 million euros for non-compliance in relation to EMIR. For many entities however, the reputational damage resulting from a fine is considered worse than the monetary sanction due to the potential repercussions on their client relationships.
Biggest changes to the reporting obligation to date
It shouldn’t come as a surprise that the latest updates to the EMIR reporting have been a focal point of discussion since its publication in the official journal of the EU in October 2022. The primary reason is that these updates are introducing the biggest changes to the reporting obligation to date. In fact, the changes are so wide reaching that most experts speak of a complete redesign of reporting rather than a simple update of the existing one.
While the total number of 129 fields which need to be reported under EMIR is already very high today, the newest update will require the entities to report 203 fields for each derivative trade (plus reporting necessary for each modification and termination) from the 29th of April 2024 on. For the impacted parties, this means that they need to correctly understand and specify the requirements for each field, map the corresponding data sources, prepare the IT implementation, and change their operational processes in the coming months. This task is further complicated by the fact that certain fields need to be filled with data that is sourced from for example a complex logic or inputs from either counterparties or external service providers. On top of that, the overall format of the reports is changing to the industry standard ISO 20022, requiring all stakeholders in the reporting value chain to be able to process inbound and outbound XML messages.
EMIR has become a differentiator - Organisation, Process, ICT
In 2014, when the EMIR reporting obligation was first introduced, many banks (in their capacity as likely reporting entity on behalf of their institutional clients) have underestimated its impact on their future servicing model. For many, the main goal was to achieve regulatory compliance in the short term, instead of developing a client service solution for their trading counterparties. However, it has crystallized that institutional clients like investment fund managers, insurance companies, family offices and operational companies are mostly relying on their trading counterparts (typically banks) to report on their behalf. In fact, the non-offering of the delegated reporting can be a reason for institutional clients to change their trading counterparty or even their custodian/service provider.
Some banks have therefore embraced the upcoming regulatory changes for a fresh start and complete redesign of their reporting setup. Allowing them to differentiate their offering by not only fulfilling the minimum reporting requirements, but through the development of a client-oriented solution targeting their institutional clients. Such a solution encompasses an enhancement of the Information and Communications Technology (ICT) and data layers as well as a re-design of the processes and organisation model around EMIR. All three dimensions are critical.
Further, the specificities of the Luxembourgish financial market with its large fund industry can thus make the offering of a compliant delegated reporting solution a differentiator for certain asset service providers.
Delegation doesn’t mean liberation
A common reason for supervisory sanctions, is the misconception that a delegation of the reporting liberates the delegating party from all its responsibilities. Even when delegating, counterparties to a derivative trade remain responsible for the data that is reported on their behalf. As such, they need to have a strong controls framework with clearly defined responsibilities in place to ensure that the reports which are sent on their behalf are correct.
From the 29th of April 2024, the entity responsible for reporting will also need to promptly notify its competent authority and, if different, also the competent authority of the reporting counterparty of any misreporting that would affect a significant number of trades, of any reporting obstacle or of any significant issue resulting in reporting errors. The CSSF has emphasized that any failure to report accurately as from the 29th of April 2024 will be considered as a non-compliance.
The next regulatory update is around the corner
Ever since the introduction of the initial reporting requirements, the number of fields to be reported has increased. The regulatory requirements have also been further enhanced and an end is not in sight since the regulatory texts for ‘EMIR 3’ have already been prepared.
In these times, regulatory changes must be embraced as potential opportunities to gain a competitive advantage. As such, it will be interesting to see which regulatory initiatives will be developed as a response to the latest inflation crisis and bank defaults.
1 e.g. FX Forwards, Swaps, Options, Futures
