The introduction of derivative reporting under the European Market Infrastructure Regulation (EMIR) has proved somewhat chaotic, but it is only a prelude to more extensive reporting to trade repositories under version two of the Markets in Financial Instruments Directive (MiFID II). Ironically, MiFID I is a source of the confused implementation of EMIR.
In a sense, the reporting obligations of the European Market Infrastructure Regulation (EMIR), like those of the Alternative Investment Fund Managers Directive (AIFMD), are nothing new. Since the Markets in Financial Instruments Directive (MiFID) came into effect in 2007, market participants have had to report transactions to regulators not just via exchanges and trading platforms but through so-called Approved Reporting Mechanisms (ARMs) that comply with the MiFID regulations.
The Financial Conduct Authority in London, for example, has approved six ARMs for MFID reporting in London: Abide Financial (see “Abide Financial,” page 80), Credit Suisse Securities (Europe Limited), CRESTCo Limited, Getco Europe Limited, the London Stock Exchange (see “UnaVista,” page 63) and Xtrakter Limited (which is owned by the MarketAxess fixed income trading platform). They are all obliged to deliver reports in formats laid down by the regulator, in much the same way as EMIR, which is why two of them –London Stock Exchange and Abide – saw an opportunity to expand their MiFID business to encompass EMIR reporting.
Ironically, MiFID has added directly to the confusion surrounding the start of EMIR reporting on 12 February 2014. Just three days after reporting started, the European Securities and Markets Authority (ESMA) was forced to issue an embarrassing request to the European Commission: “Please clarify the definition of a derivative or derivative contract under EMIR.” For a regulation that required reporting of derivatives, this was an astonishing development.
The problem arose because the definition of a derivative in EMIR derived from the definition of a derivative in MiFiD. This had created room for national regulators to decide what is and is not reported in Europe, because MiFID is a Directive (which leaves room for local interpretation) and not a Regulation (which does not). Problems arose over foreign exchange hedging arrangements in particular.
The Financial Conduct Authority (FCA) in the United Kingdom, for example, exempted commercial foreign exchange forward contracts from the EMIR reporting obligation if the settlement period was up to seven days hence. This made sense, since it matched a corresponding exemption under the Dodd-Frank Act in the United States. However, all other European regulators did not take the same view, and insisted foreign exchange transactions be excluded only if the settlement period was no more than two days hence.
Since foreign exchange transactions are voluminous, this was a non-trivial problem in terms of the number of transactions to be reported, let alone the complexity of reporting different sets of transactions in different jurisdictions. “The way EMIR has been implemented, although it is based on MiFID, has produced a definition of a derivative that does not really address the commercial purpose of a forward position, and does not address what the difference is between a forward, a future and a spot in any detail,” says Richard Frase, a partner at law firm Dechert. “For managers that do not really do derivatives, it can be the difference between no reporting at all and suddenly finding that you have got hundreds of transactions to report.”
The ESMA letter to the Commission made plain the problem. “The different transpositions of MiFID across Member States mean that there is no single, commonly adopted definition of derivative or derivative contract in the European Union, thus preventing the convergent application of EMIR,” it read. “This is particularly true in the case of foreign exchange forwards and physically settled commodity forwards. Differences in the definitions of what constitutes a derivative or derivative contract will result in the inconsistent application of EMIR, whose primary objective is regulating derivatives transactions … ESMA considers that for ensuring a consistent application of EMIR it is essential that the references to the MiFID definitions in the context of EMIR are clarified.”
The letter also made clear that achieving clarity was a matter of urgency. “Until the Commission provides clarification,” wrote ESMA, “and to the extent permitted under national law, National Competent Authorities will not implement the relevant provisions of EMIR for contracts that are not clearly identified as derivatives contracts across the Union, in particular FX forwards with a settlement date up to seven days, FX forwards concluded for commercial purposes, and physically settled commodity forwards.”
A verdict is awaited, with reporting of foreign exchange forwards on hold. As it happens, the Directive versus Regulation problem will be solved under MiFID II, which is expected to be implemented in 2016. That measure is to be accompanied by the Markets in Financial Instruments Regulation (MiFIR). In fact, aspects of EMIR reporting, such as Legal Entity Identifiers (LEIs), provide useful experience for their use under MiFIR. A number of ARMs, software application vendors and other providers of delegated reporting services are building platforms that will enable fund managers to report under both EMIR and MiFIR. MiFID II – which distinguishes between regulated markets, multilateral trading facilities (MTFs) and a new class of trading platform called Organised Trading Facilities (OTFs) - in Europe, will also introduce the swap trading platforms introduced under the Dodd Frank Act in the United States.
As OTFs, swap trading platforms will be subject to price transparency reporting obligations, though the robustness of those obligations will not be known for some time. What is certain is that OTC and exchange-traded derivative reporting under EMIR is a precursor to reporting of virtually everything to trade repositories, since MiFID II and MiFIR will extend reporting beyond equities to encompass every asset classes. Since derivative reporting to trade repositories will be two years old by 2016, every trade repository is likely to become an ARM, if only to save their clients having to use more than one agency. “Managers will not want to report the information once under EMIR and the same information again for MiFID,” explains Richard Young, head of regulatory affairs at SWIFT.