EMIR 3.0 final text published – what does it mean for users of derivatives?

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.

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 NFC 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) 

Previously, EMIR exempted transactions with certain EU pension schemes from the clearing obligation, but this exemption did 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 as long as a UK exemption for these schemes remains in place.

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.

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.

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

First, a new Article 7d 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 17 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 will be set at an amount up to 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.

Currently, EMIR allows exemptions from certain of the clearing and mandatory margining 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.

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.

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.

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.

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. 

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.

Scope of active account requirement

Clearing services within scope

The active account requirement will apply only to certain clearing services provided by Tier 2 CCPs, and not to all categories of derivatives that are subject to the clearing obligation. Clearing services subject to the active account requirement are those deemed by ESMA to be of substantial systemic importance (SSI) to the EU or any of its Member States. Initially, ESMA has concluded that the SSI categories should be confined to clearing services in interest rate derivatives denominated in euro or Polish zloty, and short-term interest rate derivatives denominated in euro.

Counterparties within scope

Counterparties that are subject to the clearing obligation and exceed the clearing thresholds in any one of the SSI categories or across all SSI categories in aggregate, will be subject to the active account requirement. If the counterparty is part of a group which is subject to consolidated supervision in the EU, the counterparty should count toward the threshold all SSI derivatives of any entity in the group including third-country entities, to avoid firms switching their cleared transactions into non-EU entities. Third-country entities who are not themselves subject to the clearing obligation do not have to maintain an active account.

Active account requirement

Counterparties who fall within scope must hold at least one account with an authorised EU CCP which is operationally ready to clear a significant number of transactions if they are moved from a third-country Tier 2 CCP. This means that the legal documentation and IT systems must be in place and the account must be permanently functional and ready to receive trades at short notice. Counterparties will have 6 months to comply with the active account requirement from the date they become subject to it.

ESMA is tasked with developing regulatory technical standards which specify the conditions for the active account and may impose more stringent operational and stress-testing requirements on counterparties who have large numbers of trades in their portfolios than on those who have fewer. As there are currently no changes to the provisions requiring clearing members to offer clients both individual and omnibus accounts it is assumed that either type of client account will be sufficient to satisfy the active account requirement. The text does however require ESMA to report to the Commission on the future feasibility of segregation of accounts across the clearing chain.

Representativeness requirement

In-scope counterparties who have a notional clearing volume outstanding of at least 6 billion euros in SSI derivatives will be required to clear a minimum number of trades at an EU authorised CCP.  These trades are to be representative of defined sub-categories of the SSI transactions, which will include buckets for maturity, size and class. ESMA will be responsible for defining the categories and sub-categories that will make up the representativeness requirement. Once defined, counterparties will be required to clear an average of no more than 5 trades in each sub-category per "reference period" over a year, the exact number per sub-category to be set by ESMA.

The reference period is also to be set by ESMA but will be at least six months for counterparties who clear less than 100bn euro of in-scope SSI derivatives, and at least one month for counterparties who clear more than that volume. Client clearing services are not included in the calculation of the notional volume for this purpose nor does the representativeness requirement apply to client clearing services (although clients will of course have to calculate their own notional volumes for these purposes as counterparties to derivatives). A counterparty must meet the representativeness requirement based on its own transactions and cannot share compliance across other entities in the group. 

A reduced representativeness requirement will apply to counterparties that enter a small number of interest rate swaps of large volume. Where the obligation would result in half or more of the counterparty's total trades for the preceding 12 months being required to be cleared in the active account, that counterparty will only be required to clear one trade in each of the subcategories. This may be relevant to larger asset managers who do use euro interest rate swaps, as they may trade fewer swaps but with large notional amounts.

Within six months of EMIR 3.0 coming into force, ESMA must publish the regulatory technical standards defining the representative categories, the reference periods and the number of derivatives per category that must be cleared via an EU CCP.

Penalties will be introduced by individual Member States for entities within their supervision who breach these requirements. These penalties will be based on up to 3% of the average daily turnover in the preceding business year for each day that the counterparty remains in breach.

Reporting compliance

In relation to the active account requirement, a new Article 7b will require counterparties to calculate and report to their competent authority the information necessary to assess compliance with the active account requirements on a six-monthly basis. Counterparties who also hold accounts at Tier 2 CCPs to clear SSI derivatives must also report their resources and systems to ensure that they are operationally able to use the active account at short notice for large volumes of derivatives. ESMA is tasked with developing the details of these requirements under Article 7a8. Again, these requirements may be less stringent for those who clear smaller volumes of derivatives.

EMIR 3.0 will come into force 20 days after publication in the Official Journal, with the exception of the changes to the calculation of aggregate positions for the purpose of applying the clearing thresholds, explained in section 2 above. Those provisions will come into force when the regulatory technical standards setting those clearing thresholds as well as specifying the criteria by which transactions will be deemed to be risk-reducing come into force. ESMA has 12 months to develop those technical standards, and they will be subject to adoption by the Commission.

There are a few steps to be completed before publication in the Official Journal. The text must be translated into the European languages, before being approved by the European Parliament. EMIR 3.0 is therefore expected to come into force in either Q2 or Q3 of 2024.

This does mean that some provisions, such as the new reporting requirements, will technically be in force while details as to how counterparties should comply have not yet been published by ESMA. EMIR 3.0 does not address this gap, but we would expect that supervisors will not enforce these requirements until such time as the necessary regulatory technical standards have been published and come into effect.

While much of the detailed requirements of EMIR 3.0 will not become clear until ESMA publishes the various regulatory technical standards, counterparties should begin to review their existing compliance arrangements and consider where EMIR 3.0 might require these to be changed or augmented. It will also be sensible for counterparties to consider whether they have the operational capacity to comply with additional reporting requirements, and to engage with their counterparties early with respect to managing transition to the new requirements.

If you have any questions about the content of this briefing, please get in touch with a member of the Derivatives and Structured Products team or your usual Travers Smith contact.