European Markets Infrastructure Regulation (EMIR) and Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA): A New Revolution of OTC Derivatives Towards Transparency
14 PagesPosted: 26 Aug 2013Last revised: 18 Mar 2014
Date Written: August 23, 2013
Both the European Union (EU) and the United States (US) have now adopted the primary legislation which aims to fulfill the G20 commitments that all standardized over-the-counter (OTC) derivatives should be cleared through central counterparties (CCPs) by end of 2012 and that OTC derivatives contracts should be reported to trade repositories (and the related commitments to a common approach to margin rules for uncleared derivatives transactions). European Securities and Markets Authority (ESMA) in Europe and the Securities Exchange Commission (SEC) as well as the Commodities Futures Trading Commission (CFTC) in the US decide which derivatives are eligible and when the clearing obligation applies. Furthermore, they are also responsible for supervising these new regulations.The US Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in July 2010 and the text of the EU Regulation on OTC Derivatives, CCPs and Trade Repositories (EMIR) was published in the Official Journal in July 2012.
There is a significant commonality of approaches between EMIR and the Dodd-Frank Act in relation to the regulation of OTC derivatives markets, but there are also some significant differences. This paper summarizes the way in which the two regimes treat different categories of counterparty and highlights certain other major differences between EMIR and the Dodd-Frank Act in relation to OTC derivatives regulation.
Keywords: Dodd Frank Act, EMIR, Regulations
Suggested Citation:Suggested Citation
Aditya, P. D., European Markets Infrastructure Regulation (EMIR) and Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA): A New Revolution of OTC Derivatives Towards Transparency (August 23, 2013). Available at SSRN: https://ssrn.com/abstract=2314998 or http://dx.doi.org/10.2139/ssrn.2314998
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Superficially, the authorities in the European Union (EU) and the United States are both pursuing the G20 agenda for derivative reporting in the same way. Under the Dodd-Frank Act and the accompanying Commodity Futures Trading Commission (CFTC) regulations, parties to swap transactions – including historical transactions in existence prior to 21 July 2010, when the Act became effective – must report the details to a swap data repository. Similarly, under the European Market Infrastructure Regulation (EMIR), which became effective on 16 August 2012, parties to swap transactions in Europe have also had to report details to a trade repository since 12 February this year. There, the similarities end.
For a start, swap reporting in the United States got under way much faster. Reporting of interest rate swaps and index credit default swaps by clearing houses (what American regulation dubs Direct Clearing Organisations, or DCOs) began in the United States as long ago as 12 October 2012. The deadline for reporting of the same instruments by swap dealers was 31 December 2012. Reporting of foreign exchange, commodity and equity swaps by both dealers and clearing houses began on 10 January 2013.
A reporting deadline of April 10 2013, set for financial counterparties that were neither swap dealers nor major swap market participants, was retained for interest rate and credit default swaps (CDS), but postponed for equity, foreign exchange and commodity swaps (29 May 2013) and for historical swaps in all asset classes (30 September 2013, or 29 June 2013 for swap agreed since 10 April 2013). Non- financial counterparties have had to report interest rate and credit swaps since 1 July 2013, and had to backload swaps of this kind agreed between 10 April and 1 July by 1 August 2013, with equity, commodity and foreign exchange swaps agreed since 10 April 2013 following suit on 19 September. Non-financial counterparties had to report historical swaps in all asset classes by 31 October 2013.
The EU, by contrast, opted for a Big Bang rather than a phased approach. All asset classes – commodities, credit, foreign exchange, equity and interest rate swaps - had to be reported from 12 February 2014. Every trade still in existence after EMIR came into effect on 16 August 2012, or concluded after it, had to be reported within 90 days, unless it was a trade that existed before 16 August 2012 and expired before 12 February 2014. New trades agreed after 16 August 2012 had to be reported within one trading day (T+1) even if they expired before 12 February 2014.
But timing was only one difference, and not the most important one. In the United States, only one of the parties to each swap - designated as the “reporting counterparty” – can assume responsibility for reporting at the time of the transaction and throughout its life. This has huge advantages for fund managers, since they can effectively leave the task of reporting to their clearing brokers. In fact, the rules oblige the broker to do the job. “Under Dodd-Frank, only one counterparty to the trade needs to report, and if one of those counterparties is a US-based swap dealer, then it is their obligation to report,” says Richard Frase, partner at Dechert. “The implications of trade repository reporting on the average US buy-side client is minimal and the whole process is straightforward.”
EMIR, on the other hand, requires both counterparties to report trades. Naturally, this has proved problematic. It puts an onus on the fund manager as well as their counterparty to report trades. It also creates a challenge: to match the data submitted by two separate counterparties, which may not even have reported it to the same repository. Initially, the difficulty of matching was exacerbated by the fact that it had to be done in the absence of a Unique Transaction Identifier (UTI) (see “UTIs: what they are, who needs one, and where to get one,” page 22). EMIR does permit buy-side swap users to delegate the reporting duty to a third party – which might be a clearing broker, or a technology vendor, or middleware provider – but their unavoidable responsibility for its accuracy means fund managers still have to do the work, or at least check it before submission.
The consequences of inaccurate reporting can include corporate and personal fines, and even prosecution, quite apart from any reputational damage. Happily, the European authorities have given fund managers a bit longer than the CFTC to make sure they get the data right. The CFTC has demanded financial institutions report data in real-time, whereas EMIR has set a T+1 deadline only. “The EMIR requirement appears to be driven by an appreciation that many buy-side firms would struggle to report trades in real-time under the two-sided reporting requirement,” explains Silas Findley, head of OTC Clearing for Europe, Middle East and Africa (EMEA) for Citi. “The CFTC, in comparison, was able to rely on the relative sophistication of market-makers’ reporting systems and was focused on providing real-time price transparency in the market.”
A further difference between the EU and the United States is that counterparties ensnared by EMIR must report exchange-traded derivatives (ETDs) as well as swaps, while the Dodd-Frank Act requires only over-the-counter (OTC) transactions to be reported. It was the immensity of this challenge that persuaded even the European Securities and Markets Authority (ESMA) to argue for pushing back the 12 February 2014 deadline. It was overruled by the European Commission. “ETD reporting presents a challenge for market participants, in part because of the sheer volume of transactions, and in particular for market participants who have not previously had regulatory reporting requirements,” says Findley.
EMIR also asks for more detail in its reports than the CFTC (see “The EMIR and Dodd-Frank Reporting Templates: A Map,” page 122). In addition to demanding information about counterparties and trading activity, the notorious 85 fields of the EMIR questionnaire seek information about collateral and how it is posted, and not just an indication of whether a trade is collateralised or not, plus data on the mark-to-market or mark-to-model valuations of each contract.