MFSA circular on EMIR supervision interactions

On February 1, 2022, the MFSA issued a Circular present its conclusions resulting from the supervisory inspections carried out with regard to the compliance of derivatives market participants with the obligations imposed under the European regulation on market infrastructures[1] (“EMIR”).

The Circular is addressed to all market participants who enter into derivative contracts and fall within the scope of the EMIR obligations. It provides valuable insight into the MFSA’s approach to these supervisory inspections as well as the relevant issues raised during these supervisory interactions.

The circular also sets out recommendations on what the AMSF considers to be good practice for compliance with EMIR obligations and is therefore extremely useful for market participants to assess their compliance with these obligations and ensure that they are properly prepared. for any future monitoring visits should these occur.

Classification of counterparties and clearing obligation thresholds

One of the issues addressed in the Circular concerns the applicability of the clearing obligation under EMIR. As a reminder, on June 17, 2019, the EMIR regulation was amended by a separate regulation[2] (“EMIR redevelopment”) which streamlined various obligations under EMIR with the aim of making regulatory obligations more proportionate.

In particular, EMIR Refit has subjected the clearing of derivative transactions to a threshold. As a general rule, certain classes of OTC derivative contracts are subject to a mandatory clearing obligation, however after EMIR Refit, the applicability of this clearing obligation depends on two main factors, namely:

  1. the classification of the entity as a financial counterparty (“CF”)[3] or a non-financial counterparty (“NFC”);[4] and
  2. the notional amounts of derivatives transactions entered into by the entity that would classify the entity entering into the derivatives transaction as an NFC- or an NFC+.

NFC entities that enter into derivatives transactions are not required to clear the transactions entered into. In addition, NFC+ entities are only required to clear OTC derivative transactions in the class for which the threshold is exceeded.

If a FC calculates its positions and the result of the calculation exceeds the clearing threshold, the FC is required to clear all OTC derivative contracts relating to any class of OTC derivatives to which the clearing obligation applies whether or not it exceeds the clearing threshold. clearing threshold for each asset class.

If the calculation of the clearing threshold is not carried out, the counterparties to the derivative transaction become subject to the clearing threshold for all OTC derivatives belonging to any category of OTC derivatives to which the obligation to compensation applies whether or not they are classified as an FC or an NFC.

Counterparties are required to immediately notify the AMSF of:

  1. if they decide not to calculate their positions in relation to the clearing thresholds;
  2. when the result of the calculation exceeds the compensation threshold; and
  3. when they no longer exceed the clearance thresholds.

In the circular, the AMSF noted that during the prudential inspections, the counterparties had not provided the calculation of the clearing threshold in accordance with their obligations and were therefore subject to the clearing obligation for all OTC derivative contracts. OTC falling within the asset classes subject to the clearing obligation.

Therefore, it is important that parties entering into derivative contracts are aware of this obligation to perform the calculation mentioned above in order to determine the extent of their regulatory obligations.

Risk mitigation techniques

Another important aspect to consider is ensuring that appropriate arrangements are in place to mitigate risk when entering into OTC derivative contracts that are not cleared.

In this regard, the MFSA’s supervisory findings were that while in general the majority of market participants met their requirements for risk mitigation techniques in practice, a number of them did not have the necessary documentation to document this.

In its comments, the MFSA refers to the importance that all risk mitigation techniques are documented and that the documentation is adequate and complete so that the documentation includes all necessary risk mitigation requirements under EMIR . This includes cases where market participants use framework agreements and industry standard protocols to ensure compliance with EMIR, as the documentation may not include all necessary provisions. Furthermore, in cases where the framework agreement was in place before the entry into force of EMIR, this agreement should be updated by means of an addendum in order to ensure that all the provisions to be put in place in accordance with the regulatory obligations in force are included.

EMIR procedures

The documentation that needs to be in place is twofold. Firstly, the market participant must have documentation regulating its relationship with its counterparty to the derivatives transaction, which documentation, as mentioned, must be up-to-date, complete and encompass the provisions required by EMIR (including risk mitigation). Second, the market participant must also have internal written procedures documenting the processes put in place to comply with its EMIR requirements.

The MFSA noted that a number of market participants were unable to provide such written procedures and recommended that all counterparties entering into or intending to enter into derivative contracts have a detailed set procedures to ensure their compliance with EMIR.

Transaction reports

Market participants should also bear in mind that the AMSF’s supervisory work is not limited solely to examining the documentation requested during its supervisory visits. In addition to these visits, the MFSA performs our off-site monitoring of transaction reports that are submitted by market participants to trade repositories (“TRs”) as required by EMIR. In this regard, Article 9 of EMIR requires that the details of derivative contracts entered into by a counterparty be reported to a TR recognized by ESMA no later than the business day following the conclusion, modification or termination of a derivative contract (T+1) .

During its off-site monitoring of reports submitted to TRs, the MFSA noted that counterparties did not report derivatives transactions in a timely manner and sometimes did not fully report transactions. He further noted that the counterparties had not declared all required mandatory data fields or filled in the details of the incorrect fields.

The Circular places particular emphasis on the MFSA’s expectation that market participants fully comply with EMIR transaction reporting requirements. It draws particular attention to the fact that the failure to submit complete and timely reports of derivatives transactions in violation of Article 9 of EMIR could justify regulatory action under Article 11 of the Law on Financial Markets (OTC Derivatives, Central Counterparties and Trade Repositories) (the “FMA regulations”).[5] Under Article 11 of the FMA Regulation, a person responsible for the reporting requirements for derivative contracts breaches or fails to comply with the provisions of EMIR or the EMIR Regulation, the AMSF may, by written notice and without recourse to a count hearing impose an administrative penalty not exceeding €150,000.

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