G20 FINANCIAL REFORM
for end-users that use swaps to hedge commercial risk and comply with certain formalities. Under EMIR, “non-financial” counterparties will generally not be required to clear transactions unless they exceed a certain “clearing threshold”. If this clearing threshold is exceeded, then a clearing obligation will apply (with a carve-out for certain hedging activity);
• Requiring counterparties to put in place additional measures to ensure the stability of derivatives
transactions that are not centrally cleared, for instance, capital, margin and collateral requirements; and
• Employing specific mechanisms to enable the consideration of compliance with third country
regimes.
... some areas of the two sets of rules do not completely align, leaving substantial scope for compliance mismatches
However well-intended the US and EU legislators
were when setting out to draft their initiatives on OTC derivatives regulation, inevitably some areas of the two sets of rules do not completely align, leaving substantial scope for compliance mismatches and practical difficulties in implementation where an entity may be subject to both regimes simultaneously. For instance:
• Applicability – Swaps versus OTC Derivatives: The Dodd-Frank definition of a swap includes any
agreement, contract or transaction that is (or becomes) commonly known in the trade as a swap, including any transaction that depends upon the occurrence of a particular event. EMIR, however, is limited to bilateral OTC contracts which are not executed on a regulated market (or third country equivalent market) – thereby excluding derivatives traded on regulated markets (which are covered separately under the Markets in Financial Instruments Directive (MiFID)).
• Reporting: Although market participants will be required to report their derivatives trades under
both Dodd-Frank and EMIR, the mechanics of reporting differ. Under Dodd-Frank, reporting of detailed transaction data will effectively need to be done in real time, whereas EMIR allows for a slight time lag in that details of transactions will not need to be reported until T+1. However, the EMIR rules arguably are stricter on what information is to be reported and how reporting occurs.
• Supervision of market participants: Entities that qualify as swap dealers or major swap participants
under Dodd-Frank are required to register and will be subject to supervision and regulation by the CFTC. The CFTC has imposed capital and
14 December 2012
margin requirements on registered entities, as well as conduct of business rules. However, EMIR does not in and of itself impose any registration or supervision requirements on entities that would be required to register with the CFTC, although such entities may be required to be authorised to operate in the EU under MiFID or other local financial services regulation.
• Timing: Some requirements and regulations of Dodd-Frank are already in effect or are expected
to be effective by the end of 2012. Although EMIR entered into force on 16 August 2012, various provisions will not be effective until the European Commission adopts technical standards (with the first set of such standards not expected to be finalised until the end of 2012).
• Extraterritorial Effect: Different methods of assessing when the rules of a regime apply to
market participants based outside of a regulator’s jurisdiction.
Failure by regulators to address these issues in a
coordinated way opens the door to the risk of regulatory arbitrage or the departure of market participants, with an attendant increase in market concentration and, arguably, systemic risk.
Extraterritoriality At first glance, it appears that Dodd-Frank and EMIR
take a similar approach to the cross-border regulation of swaps, each providing for extraterritorial effect in circumstances where (broadly):
– the parties’ arrangements are deemed to have a sufficiently significant impact on geographical areas within the remit of the rules; or
– it is deemed necessary for the legislation to apply in order to deter parties from concluding transactions intended to evade it.
Dodd-Frank applies to activities taking place outside
of the US only if they either (i) have a direct and significant connection with activities in, or effect on, commerce in the US, or (ii) are in violation of CFTC rules aimed at preventing the evasion of Dodd-Frank requirements (s. 722(d)). Under EMIR, where a contract is concluded between
an EU based entity that is subject to the clearing requirement under EMIR and a non-EU entity that would have been subject to the clearing requirement if it was established in the EU, EMIR will apply. In addition to this, EMIR is intended to have extraterritorial effect where two non-EU counterparties enter into an ‘eligible’ contract and either: (i) the contract has a “direct, substantial and foreseeable effect” within the EU; or (ii) it is necessary or appropriate for EMIR to apply to their arrangements in order to prevent the evasion of any provision of EMIR. Moreover, the broad extraterritorial powers in
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