European Union: EMIR 3.0 Final Text Approved – What Does It Mean For Users Of Derivatives?

EMIR directly applies to EU counterparties, however UK and other non-EU counterparties will be affected when they enter derivatives transactions with EU entities who are subject to the clearing, margining and reporting requirements of EMIR. The UK version of EMIR remains unaltered by EMIR 3.0 discussed here, but it is expected to be reviewed under the provisions of the Financial Services and Markets Act 2023.

Overall, EMIR 3.0 leaves much of the detail of the new requirements to be developed by ESMA, so it may be some time before the market has a full picture of what counterparties will be required to do to comply. This briefing outlines the main provisions but note that the details may change as regulatory technical standards are published.

Our briefing is aimed primarily at UK buy-side participants such as UK pension schemes and asset managers, however the changes brought in by EMIR 3.0 are relevant to all counterparties mentioned above.

Calculation of clearing threshold

EMIR requires counterparties to clear their OTC derivatives if their average aggregate positions in certain classes of derivatives over certain periods exceed prescribed clearing thresholds. EMIR 3.0 amends the scope of the derivatives that must be included in the aggregate positions to be measured against the clearing thresholds.

Financial Counterparties (FCs) and Non-Financial Counterparties (NFCs)

EMIR categorises derivative counterparties as "financial" or "non-financial", with financial counterparties generally being subject to stricter rules than non-financial counterparties.

Financial counterparties include EU supervised entities such as banks, investment firms, insurers, pension funds, UCITs and AIFs. Non-financial counterparties are all other counterparties to derivatives transactions and will include certain SPVs who engage in derivatives activity.

Counterparties are further separated into FCs and NFCs whose aggregate month-end average position in OTC derivatives for the previous twelve months exceed certain thresholds. These thresholds are currently:

• 3 billion euro gross notional value for interest rate derivatives
  
  
• 3 billion euro gross notional value for foreign exchange derivatives
  
  
• 1 billion euro gross notional value for equity derivatives
  
  
• 4 billion euro gross notional value for commodity derivatives

Where these thresholds are exceeded, the counterparty will become subject to the clearing obligation. The OTC derivatives that must be included by a counterparty in determining its aggregate positions for applying the thresholds will change when EMIR 3.0 comes into force.

FCs and NFCs are generally referred to as "FC+" and "NFC+" or "FC-" and "NFC-" respectively according to whether they exceed the thresholds or not.

For NFCs there are two changes to the aggregate measure. First, while the current version of EMIR requires an NFC to calculate its positions in both cleared and uncleared OTC derivatives that are not risk-reducing, the final text allows NFCs to exclude derivatives that are cleared through an authorised or recognised CCP. NFCs will continue to be able to exclude derivatives which are objectively measurable as reducing risks directly relating to the commercial or treasury activity of the NFC itself or the group to which it belongs.

Second, while the current version of EMIR requires NFCs to count all OTC derivatives entered by any entity within the group, the final text of EMIR 3.0 restricts the count to uncleared OTC derivatives entered by the NFC itself.

The effect of these two amendments together is that NFCs such as SPVs within a fund group will only have to include their own uncleared speculative derivatives when determining whether they exceed the clearing thresholds and will not have to count derivatives entered by other SPVs within the fund.

Although at first sight this appears to be beneficial for NFCs, ESMA is required, within 12 months of EMIR 3.0 coming into force, to produce regulatory technical standards that set new values for the clearing thresholds to be applied by NFCs. The final text of EMIR 3.0 will also require ESMA to develop regulatory technical standards specifying criteria for establishing which OTC derivatives are risk-reducing and can thus be excluded by NFCs from the measure of their uncleared derivatives transactions. We may therefore see some tightening of these criteria alongside the setting of new clearing thresholds. Accordingly, while there is some good news for NFCs in that they will not need to include positions of group entities in their calculations, the full impact of the changes cannot yet be assessed.

Where financial counterparties calculate their positions for the purpose of applying the clearing thresholds, the calculation is different. It now has two alternative measures, either one of which will trigger the clearing obligation. The first measure is the uncleared positions of the FC and (unlike NFCs) all entities in its group. The second measure is the aggregate of its cleared and uncleared OTC derivatives entered by the FC or entities in its group. While the two separate measures do not at first appear to be independent, ESMA is again given a mandate within 12 months to set separate clearing thresholds for each of these measures for FCs, which we assume will be set at different levels.

The original Commission proposal had been that FCs, like NFCs, would need to only count uncleared derivatives but the agreed text effectively maintains the current position under EMIR – i.e. FCs must count all OTC derivatives whether cleared or uncleared, which would include derivatives executed on a UK trading venue as these derivatives are treated as OTC derivatives for the purpose of EMIR.

As FCs still have to count derivatives entered by group entities, this remains important in the context of groups in which hedging is undertaken by NFCs. If an FC has hedging vehicles within its group which are NFCs, the NFC will not have to include derivatives entered by other entities in the group toward its own clearing threshold and will benefit from the exclusion of derivatives that are risk-reducing from the measure. The FC, however, will have to count the derivatives entered by the hedging vehicle, as there is no exclusion for hedging derivatives in the measure applying to FCs. Fortunately, the existing derogation which allows Alternative Investment Funds (AIFs) and Undertakings for Collective Investment in Transferable Securities (UCITS) to calculate positions at the level of the fund has been retained, so this anomaly is less likely to arise in the funds context.

Note that for both NFCs and FCs, the calculation of uncleared positions includes derivatives that are not cleared by an EU authorised CCP or by a third-country recognised CCP. Three UK CCPs are currently recognised by the EU until the end of June 2025¹.

[1] ICE Clear Europe Ltd, LCH Ltd (as Tier 2 CCPs) and LME Clear Ltd (as a Tier 1 CCP)

Pension Scheme Clearing Exemption

Currently, EMIR exempts transactions with certain EU pension schemes from the clearing obligation, but this exemption does not extend to transactions with third country schemes such as those established in the UK.

EMIR 3.0 introduces a permanent exemption from clearing for EU counterparties who are over the clearing thresholds where they enter transactions with third country pension schemes where those schemes are authorised, supervised and recognised under national law and are within the scope of a clearing exemption in their home jurisdiction. This exemption is not subject to an equivalence decision by the EU Commission in respect of the home jurisdiction's supervisory regime, so it would seem that UK pension schemes are contemplated by this exemption, and derivatives between EU counterparties and UK pension schemes will not be required to be cleared.

Exemption from margining for Single Stock Equity Options and Index Options

EMIR requires counterparties to uncleared derivatives to post variation margin, and where their volumes of trading exceed set thresholds, to post initial margin. To date there has been a time-limited exemption from mandatory margining in the case of certain equity derivatives. The current exemption is expected to expire on 4 January 2026.

The final text introduces a permanent exemption from mandatory exchange of initial and variation margin for uncleared single stock equity options and equity index options. The new exemption is to be reviewed by ESMA every 3 years and is removable by the Commission but the market will have at least two years' notice should the Commission decide to remove it.

NFC Margin Implementation Period

EMIR 3.0 will give NFCs who become subject to mandatory margin requirements, including requirements to post variation margin and initial margin, a new 4-month implementation period to set up the relevant arrangements to meet these obligations. During this period any new derivatives entered will be exempt from the margin requirements. Currently, EMIR does not give counterparties a clear lead-in period for applying margining arrangements, and EMIR 3.0 allows a period which is in line with the period allowed for compliance with the clearing obligation when NFCs exceed the clearing thresholds.

Reporting Requirements

The final text includes multiple new reporting requirements, the most relevant of which for buy-side counterparties are the following:

First, a new Article 7ba requires EU clearing members and clearing clients who clear in recognised third country CCPs to report details of their clearing activity in those third country CCPs to their competent authorities. EU parents must report the clearing activities of group entities subject to consolidated supervision in the EU. These reports must include type of instrument, average values cleared over a year, margins collected, default fund contributions and the largest payment obligation. Recital 13 to the text suggests that this obligation will extend not just to OTC derivatives transactions but also securities transactions (which could include repo) and exchange-traded derivatives, whereas the substantive text does not specify the covered instruments. Again, the details of these reports are to be developed by ESMA within 12 months of EMIR 3.0 coming into force, so it may be that the in-scope instruments are specified at that stage.

Second, there is a new reporting requirement for NFC+ whose intragroup trades have until now been eligible for an exemption from reporting requirements. Such NFC+ may still benefit from the existing reporting exemption for NFCs with regard to intragroup transactions however, where it has an EU parent, the parent will have to report to its competent authority the net aggregate positions per class of derivatives on a weekly basis.

As part of a general requirement to improve data reporting under EMIR, there is a new requirement that FCs and NFCs who are subject to the reporting obligation put in place appropriate procedures and arrangements to ensure the quality of the data they report, and ESMA (together with the EBA and EIOPA) is tasked with developing technical standards governing these arrangements.

Alongside this, the text introduces penalties on counterparties who repeatedly include manifest errors in the data they report. These penalties are based on 1% of average daily turnover per day of breach. Counterparties will also be required to disclose publicly all penalties imposed for data breaches. While many NCAs have reserved the right to issue fines for EMIR reporting breaches, this is the first time a quantifiable financial penalty for breach of reporting requirements has been enshrined in the primary legislation and suggests that in future ESMA may be less lenient than it might have been to date. EU counterparties should already be reviewing their operational capability to meet the new trade reporting requirements coming into force in late April 2024 (as detailed in our previous briefing) and this penalty provision brings those preparations into sharper focus. It should be noted that where counterparties delegate their reporting, they remain responsible for the accuracy of the data and will therefore be subject to the new penalties where they breach their obligations.

ESMA is required to develop regulatory technical standards within 12 months of EMIR 3.0 coming into force, specifying what will constitute a manifest error for the purpose of applying the new penalties.

Intragroup Transactions - Removal of Need for Equivalence Decision

Currently, EMIR allows exemptions from certain of the clearing, mandatory margining and reporting requirements for OTC derivatives transactions between counterparties in the same group ("intragroup transactions"). Where the group counterparty is a third country entity, counterparties can currently only treat the transaction as an intragroup transaction where an "equivalence" decision has been made by the Commission to the effect that the third country's legal and supervisory regimes are equivalent to the relevant requirements laid down in EMIR.

In the final text, this requirement for an equivalence decision is removed for the purpose of the intragroup exemptions in favour of a requirement that the counterparty is not in a "high risk" jurisdiction which either has deficiencies in its anti-money-laundering or counter-terrorist regime or is on the EU list of non-cooperative tax jurisdictions. The EU Commission may on an ad hoc basis identify other jurisdictions that should not benefit from the intragroup exemptions. Happily, neither the UK nor the US appears on either list so transactions with UK and US entities can benefit from the intragroup exemptions where applicable without the need for an equivalence decision.

Restriction of Article 13 Equivalence

Currently under EMIR, Article 13 provides that where a decision has been adopted by the Commission in respect of a third country to the effect that the legal and regulatory regimes of a third country are equivalent to the clearing, margining and reporting requirements under EMIR, counterparties entering OTC derivatives with entities in such a third country will be deemed to have complied with those provisions under EMIR. The effect of this is to avoid counterparties having to comply with a double obligation under EMIR and the requirements of the third country.

The final text restricts this deemed compliance to apply only to the margin requirements. As such, in situations other than intragroup transactions (which benefit from the exemption explained above), it appears that, as a result of EMIR 3.0, conflicting sets of rules governing clearing and reporting requirements may be more likely to arise where EU counterparties trade with third country entities.

In instances in which a third country's clearing obligation applies to the third country counterparty, and the clearing obligation under EMIR applies to the EU counterparty, it appears that EMIR will now allow the transaction to be cleared in the third country CCP only if that CCP is on the list of CCPs recognised by ESMA. In the case of two sets of reporting requirements applying, it seems that both will apply.

Post-Trade Risk Reduction Transactions

The final text includes a new provision that exempts from the clearing obligation OTC derivatives resulting from post-trade risk reduction (PTRR) exercises, provided they meet certain conditions. The conditions include that the PTRR exercise is conducted by an independent authorised person and takes the form of a compression, rebalancing or optimisation exercise or a combination of these, and must be market risk neutral. In order to benefit from the exemption, participants cannot choose which trades within the submitted portfolio will be executed under the PTRR exercise and cannot influence it. The PTRR provider will be subject to monitoring and reporting obligations.

Initial Margin Model Approval and Validation

The final text introduces new requirements for supervisory authorisation and validation of initial margin models. Asset managers and pension schemes which are required to exchange initial margin tend to use industry-wide "pro-forma" models such as the ISDA SIMM, rather than bespoke margin models. Counterparties will only be able to use such pro-forma models if the model or change to such model has been validated by the EBA. The EBA will charge EU counterparties a fee for use of the pro-forma models it validates, based on the notional amount of uncleared OTC derivatives for which the counterparty uses the model. These fees will be set out by the Commission. This differs from the position so far taken by the UK FCA, which has stated that it does not currently intend to require pre-approval for the use of initial margin models. UK buy-side counterparties may see fees being passed on by their EU counterparties as a result.

Transparency of Margin Requirements in Cleared Transactions

EMIR 3.0 sets out new provisions requiring clearing members of CCPs to enable their clients to predict the likelihood of margin calls, particularly during stress events.

Clearing members will be required to explain to clients how cleared margin models work, including simulations showing the implications for their clients during periods of market stress. Further details of these requirements are to be developed by ESMA. It is not clear what the consequences will be for clearing members who fail to meet these transparency requirements and, in particular, whether there will be any remedy available to clients, although the simulations will not be binding.

Active Accounts

One of the main headlines from the political negotiation around EMIR 3.0 has been the attempt to incentivise EU counterparties to derivatives to clear certain derivatives on an EU authorised CCP, rather than on recognised third-country Tier 2 CCPs such as the London Clearing House. This has resulted in the introduction of an EU "active account" requirement, which requires the holding of an account with an EU CCP and the clearing of certain euro-denominated instruments through that account.

This requirement will not generally be relevant to UK pension schemes as many do not routinely enter euro-denominated swaps. UK asset managers may be caught if they enter large volumes of euro-denominated swaps, but in many cases asset managers will not trade in the volumes which would trigger the requirement. The summary below is therefore generally more relevant to investment firms who trade in euro-denominated instruments.

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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.