The deadline for EMIR is nearing and industry participants are worried about the tight timeframes for compliance with this new regulation of the OTC derivatives space.
It is often said that in the financial markets, timing is everything. For derivatives industry executives, concerns over the timing of the implementation of the new European Market Infrastructure Regulation (EMIR) is just one strand of a complex nest of issues, although potentially the most important one. Says Andrew Douglas, head of public affairs, Europe at the DTCC. “There is an issue that is not being talked about and that is about the timing of compliance.”
The derivatives industry was given just four weeks to respond to what was billed as a preliminary discussion paper from the European Securities and Markets Authority (ESMA) in March on draft technical standards for the regulation of OTC derivatives, central counterparties and trade repositories. ESMA is meant to digest the hundreds of pages of analysis and then produce its only official consultation on the actual technical standards in late May or June. The regulatory organisation is then bound to wrap up its proceedings by 30 September so that the standards can be finalised by the European Union machine before the Group-of-20 deadline of 31 December.
While the derivatives industry is concerned about the tightness of this drafting process, it is even more concerned about the kind of timeframes it will have to build the physical infrastructure required by these new rules. Officially speaking, the new rules come into force on January 1, 2013, but compliance at that date by the industry will be next to impossible, say a range of experts.
Douglas explains: “There is a proposed six month authorisation window during which central counterparties (CCPs) and trade repositories that operate in the EU will be required to submit their authorisation applications in line with the rules that will have been published from ESMA. “So the big question on the minds of many in the industry is, does that six month window start on January 1, if we assume everything is in place on the 31st of December? If that is the case, a CCP or a trade repository is likely going to be sceptical of applying for authorisation without a confidence level that they are compliant with the rules and the Level 1 text. However, they won’t have known with any certainty what those rules were until yesterday, if today is January 1. So is there going to be a grace period during which repositories and CCPs will be allowed to look at the final rules, work out and execute whatever needs to be done to be compliant, and then go into the six month authorisation process? Or does the six month authorisation process start immediately after the rules have been approved, in which case when are they supposed to develop their compliance?”
This isn’t just an issue for CCPs and trade repositories, Douglas adds. Once those organisations have determined what they need to do to be compliant with the new EMIR regulations, then banks, brokers and other financial services firms will need to work out what they will need to do to be able to interface, technologically and in terms of processes, with these infrastructure organisations. Says Douglas, “They won’t be able to start their work until the infrastructures have decided what they are going to do. This is, unfortunately, a serial process.”
There are other places in which there is a problematic chain reaction. For example, the use of indirect clearing relationships – in which smaller institutions or brokers, who are not clearing members, are able to pass along trades they are conducting on behalf of their clients to larger banks that are clearing members – is welcomed by the industry, which initially feared that such relationships would not be permitted. But putting indirect clearing relationships in place that meet the new EMIR criteria can’t be accomplished overnight.
“What we are hearing from our small and medium-sized banks is that this takes time – it takes five or six months” to negotiate such [indirect clearing] arrangements, says Joe McHale, financial markets advisor at the European Banking Federation (EBF) in Brussels. “So by the time these firms get the EMIR standards in terms of what they should look like, and then afterwards to try and negotiate these indirect clearing arrangements, there is a worry that it will be difficult to adhere to EMIR as of 1 January.” The EBF have asked for a phase-in period for banks to be able to put these relationships in place, and the organisation is concerned that this phase in period is handled correctly by ESMA so that smaller, regional or national banks won’t be forced out of certain lines of derivatives businesses if they cannot conclude arrangements with a clearing member. This issue could be addressed in connection with the phasing-in of the clearing-obligation in respect of certain classes of derivatives, he adds.
Another timing issue is the implementation of the EMIR framework for individual derivative products. The industry expects that all derivative products will not be launched into the new EMIR system at once, but that classes of derivatives will be introduced in stages. So far, there has been no indication from ESMA as to how the classes of product will be broken out or over what period the staggered introduction will take place.
As well, says Jonathan Herbst, partner at Norton Rose in London, “a type of specific consultation on each product type will need to be done, including economic analysis. In my own mind, I’m not clear how that is going to be done.” Herbst says ESMA will “need to consult on products coming in from the top down. I’m not sure how deep that is going to go. How they are going to define the products, that is a big issue.”
Industry experts say they believe that ESMA will move heaven and earth to ensure that the package of technical standards is ready to go live on January 1, 2013, to meet the G-20 deadline.
This still leaves the problem of the ability of the industry to put in place the vast infrastructure required to comply with EMIR, and most concede that what “hitting the deadline” means could be open to a classic civil servant style of fudge. Although EMIR will be “live” on January 1, 2013, the reality is that most of it will be implemented over the course of 2014 and 2015. “It is more the subtle point about what does hitting the deadline really mean,” says Herbst, “I suspect what we will actually have is a bit of a fanfare but in the real world there will be a more staggered implementation, so [ESMA] are almost speaking with a forked tongue. I would be quite surprised if that isn’t what happens.” For the industry, this is perfectly acceptable. Adds Herbst, “To be fair, I think the industry doesn’t want to push the point too hard. It suits everybody to allow a bit more time for the work without putting ESMA into a corner. There is a community interest.”
