EMIR collateral margin reform

Under EMIR and as part of the obligation to use risk-mitigation techniques, financial counterparties (including most investment funds) and large non-financial counterparties are required to exchange collateral where OTC derivatives are not centrally cleared.

In December 2016, the EU regulatory technical standards (Commission Delegated Regulation 2016/2251) supplementing EMIR with regard to the risk-mitigation techniques applicable to non-centrally cleared OTC derivatives ("Margin RTS") were published in the Official Journal of the EU.

The Margin RTS specify the various procedures that counterparties must include in their risk management procedure. They also set out the methodology to be used for calculating initial and variation margins as well as the eligibility and diversification criteria with which they have to comply.

The Margin RTS provide various phase-in dates for its application and exemptions.

In a nutshell:

• For initial margin: the implementation will vary depending on the size of the counterparties from 4 February 2017 (for the largest market participants with an aggregate average notional amount ("AANA") of non-centrally cleared derivatives above EUR 3 trillion) until 1 September 2020 (for counterparties with an AANA above EUR 8 billion). Counterparties whose AANA is below the EUR 8 billion threshold will be exempt from initial margin requirement.
• For variation margin, the obligation to calculate and provide variation margin applies:
  • as from 4 February 2017, where the two counterparties to a non-centrally cleared derivative have both, or belong to groups each of which has, an AANA above EUR 3 trillion;
  • as from 1 March 2017, for all other counterparties, including most investment funds.
• FX forwards, FX swaps, currency swaps are all in scope (which is not the case for instance in the US for certain FX derivatives). However, there is no obligation to collect initial margins for such derivatives. In addition, with respect to FX forwards only, the requirement to exchange variation margins is postponed until (presumably) 3 January 2018. 

On 23 February 2017, the European Supervisory Authorities ("ESAs") published a paper (in the form of a communication) on variation margin exchange set out in the Margin RTS in which they acknowledged that the entry into force of the variation margin requirement as from 1 March 2017 appears mainly to pose a challenge for smaller counterparties. Although the ESAs stated that the postponement of this requirement would need to be implemented formally through EU legislation, they indicated that national competent authorities can take into account the size of the exposure to the counterparty and its default risk in assessing compliance of counterparties with Margin RTS requirements. The ESAs underlined that this approach does not entail a general forbearance, but a case-by-case assessment from the competent authorities on the degree of compliance and progress. On the same day, IOSCO also published a similar statement.

The Commission de Surveillance du Secteur Financier ("CSSF") has not yet formally taken a position on this new obligation; however, one may reasonably expect that that they will adopt a softer approach for smaller counterparties and will be less flexible with large counterparties.

In all cases, once the Margin RTS apply to them, management companies AIFM and, if applicable, investment managers, will need to take all necessary steps to comply with these new rules (in particular updating the relevant credit support documentation and establishing specific risk management procedures).