EMIR: A Guide For Irish Funds

Author:Ms Karen Jennings
Profession:Dillon Eustace
 
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Introduction

On 4 July 2012, the Regulation on OTC Derivatives, Central Counterparties and Trade Repositories1 (known as "EMIR") was adopted and entered into force on 16 August 2012. This was a major development which enables the European Union to deliver the G20 commitments on OTC derivatives agreed in Pittsburgh in September 2009.

EMIR introduces fundamental changes in the trading of OTC derivatives2 and Irish funds will be captured by the new obligations if they enter into derivatives3. The obligations will apply regardless of whether an Irish fund enters into derivatives contracts directly or through an agent (such as the fund's asset manager).

For an Irish fund, the key implications of EMIR are;

The introduction of risk mitigation obligations in respect of non-centrally cleared trades; The introduction of obligations to report derivatives to a trade repository ("TR"); The introduction of a clearing obligation relating to certain eligible OTC derivatives; and The introduction of the collateralisation requirements for non-centrally cleared OTC derivative contracts. This Article will outline the implications of EMIR for Irish funds and the steps to be considered by such funds/their asset managers. EMIR applies to EU firms even when trading with non-EU firms and has extraterritorial effect in some circumstances

Categories of counterparty under EMIR

As a starting point, an Irish fund will need to determine whether or not it is a "financial counterparty" or a "non-financial counterparty" as defined under EMIR. The nature and extent of the obligations of an Irish fund will depend on its categorisation under EMIR.

A Financial counterparty ("FC")4 includes UCITS funds and AIFs managed by an AIFM authorised or managed under AIFMD (i.e. EEA AIFMs). The FC definition would capture, for example, a Cayman hedge fund managed by an EU AIFM, once the EU AIFM is authorized or registered under the AIFMD.

A Non-financial counterparty ("NFC")5is any undertaking established in the EU other than an NFC. Hence it will include a non-UCITS fund in Ireland whose manager is not authorised or registered under AIFMD. For example, Irish or Luxembourg funds managed by a U.S. manager. If the fund is an NFC, it must further determine whether or not it is an NFC+ or an NFC-. An NFC+ is an NFC if the rolling average position of its derivative trading positions over 30 days exceeds one of the clearing thresholds6 (the "Clearing Thresholds"). An NFC- is an NFC whose derivative trading positions do not exceed any such Clearing Thresholds.

In respect of an NFC, once the Clearing Threshold is exceeded, the NFC must "immediately notify ESMA and the competent authority"7. This requirement has been in effect since 15 March, 2013.

Steps to be taken by Irish funds: An Irish fund which is an NFC may wish to appoint a delegate (such as its asset manager) to calculate on each business day whether or not the Clearing Threshold has been met and if so, to notify the fund, ESMA and the Central Bank accordingly. Responsibilities in the fund's investment management agreement should be reviewed and amended accordingly.

Risk Mitigation Requirements for Non-Centrally Cleared OTC Derivatives

Irish funds who enter into OTC derivative transactions not cleared by a CCP must "ensure, exercising due diligence, that appropriate procedures and arrangements are in place to measure, monitor and mitigate operational risk and credit risk"8. Further details are set out below. These requirements generally apply to all Irish funds (i.e. all FCs, NFC+ or NFC-) save for the daily valuation requirement which does not apply to an NFC-.

Timely confirmations: All Irish funds (i.e. FCs and NFCs) are required to have in place procedures and systems to ensure that uncleared OTC derivatives are confirmed (where possible by electronic means) as between the parties within the deadlines set out in the applicable technical standards issued pursuant to EMIR9. These deadlines vary depending on the type of derivatives involved and the nature of the Irish fund (i.e. whether or not it is an FC, an NFC+ or an NFC-)10. In addition, please note that an Irish fund which is an FC (but not an NFC) must report on a monthly basis to the competent authority the uncleared OTC derivative contracts that are outstanding for more than 5 business days11.

Application: These requirements apply to any uncleared OTC derivative contract to which the Irish fund (FC or NFC) is a party irrespective of the identity/location of the other party. It is also worthwhile noting that the requirements apply to contracts between two third country entities that would be subject to the clearing obligation if they were established in the EU, provided that the contract has a "direct, substantial and foreseeable effect within the" EU "or where such an obligation is necessary or appropriate to prevent the evasion of any provisions of [EMIR]"12.

Effective Date: Phased in from 15 March 201313.

Steps to be taken by Irish funds: Each Irish fund should ensure that it (or a delegate of the fund such as its asset manager) has infrastructure in place to discharge these requirements. Responsibilities in the fund's investment management agreement should be reviewed and amended.

Portfolio Reconciliation: All Irish funds (i.e. FCs and NFCs) are required to agree in writing means by which portfolios of uncleared OTC derivative contracts shall be reconciled with each of their counterparties14. The reconciliation (which may be carried out in-house or delegated to a third party) must cover key trade terms and the valuation attributed to each uncleared OTC transaction15. The frequency of portfolio reconciliation depends on the number of outstanding contracts which are not centrally cleared and whether the counterparty is an FC, an NFC+ or an NFC-16.

Application: These requirements apply to any uncleared OTC derivative contract to which the Irish fund (FC or NFC) is a party irrespective of the identity/location of the other party. It is also worthwhile noting that the requirements apply to contracts between two third country entities that would be subject to the clearing obligation if they were established in the EU, provided that the contract has a "direct...

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