Emir

A substantial portion of OTC derivatives are not standardized and therefore will not be centrally cleared. To further reduce counterparty risk inherent to such trades, EMIR introduced risk mitigation techniques applicable to all non-centrally cleared transactions in both pre- and post-trade space. Those include timely confirmation, portfolio reconciliation and compression, dispute resolution, daily valuation and the exchange of collateral.

• Timely confirmation

Requires counterparties to document the agreement of all the terms of a contract. While the requirement applies to both financial and non-financial counterparties, the timing depends on the classification of an entity under EMIR and the type of the OTC derivative traded.

• Portfolio reconciliation

Mandates counterparties to reconcile key trade terms identifying particular OTC derivative contract to identify any discrepancies, including its valuation. The required frequency of reconciliation depends on the nature of the counterparty and the number of trades outstanding with respective counterpart.

• Portfolio compression

Counterparties with more than 500 outstanding OTC derivative contracts with each other are to have in place procedures that allow them to regularly analyze whether a portfolio compression is possible.

• Dispute resolution

Requires counterparties to agree procedures and processes to identify, record and monitor disputes related to the valuation of the OTC contract and to the exchange of collateral between counterparties, as well as to resolve disputes in a timely manner. Counterparties can be required to report long lasting, high value disputes to a local regulator.

• Daily valuation

Certain counterparties are to perform daily mark-to-market valuation of the outstanding contracts. Only if market conditions do not allow for the employment of a mark-to-market valuation, for example if the market is inactive or where the range of fair estimates is significant, a reliable and prudent mark-to-model method may be used.

• Exchange of collateral

Both financial and non-financial counterparties are required to exchange two-way initial margin (IM) and variation margin (VM) with respect to OTC trades that are not centrally cleared.

IM refers to the collateral collected to cover a counterparty’s current and potential future exposure between the last margin collection and the liquidation of positions or hedging following a default of the other counterparty. Initial margin is to be exchanged on a gross basis. Furthermore, to reflect the results of the daily mark-to-market or mark-to-model of outstanding contracts, counterparties are to exchange additional collateral referred to as a VM.

VM applies to all counterparties and does not have a materiality threshold.

All counterparties are required to report on OTC and exchange-traded (ETD) derivative trades to a registered trade repository (TR), using a unique Legal Entity Identifier (LEI). The reporting must take place following the execution of a trade and on an ongoing basis, should the contract be subject to any changes or a termination. While nominally both parties are required to submit a report on each trade, either party could choose to delegate reporting to a third party or enter into an arrangement whereby one party reports on behalf of both counterparties. The detailed requirements pertaining to regulatory reporting are set out in the final EMIR technical standards.