EMIR: Implementation Update and Implications for OTC Derivatives March 5, 2014 Barney Reynolds, Partner, Shearman & Sterling Geoff Goldman, Partner, Shearman & Sterling Thomas Donegan, Partner, Shearman & Sterling Adam Jacobs, AIMA Copyright 2014 Shearman & Sterling LLP. Shearman & Sterling LLP is a limited liability partnership organized under the laws of the State of Delaware, with an affiliated limited liability partnership organized for the practice of law in the United Kingdom and Italy and an affiliated partnership organized for the practice of law in Hong Kong.
Welcome and Introduction
Our objectives for this conference session To give a brief overview of the key aspects of derivatives regulation and compliance requirements Assist market participants in evaluating their various options by considering: Current state of play in derivatives regulation in the US and Europe Considerations for Central Clearing Changes to documentation for clearing and the interrelation between EMIR and Dodd- Frank documentation Extraterritoriality of EU and US measures US substituted compliance European equivalence Reporting and conduct of business requirements QCCP issues 3
Derivatives Regulation in the United States and Europe Overhaul of regulation of derivative products and market participants Based upon 2009 G-20 Pittsburgh summit commitments Similar reforms being enacted by all G-20 nations slowly in some cases! US and EU regulators have made the most progress Key Features of Dodd-Frank Title VII: Regulation of derivatives by the CFTC and/or SEC Clearing and exchange trading of many derivatives Margin requirements for cleared and uncleared swaps Registration required for Swap Dealers and Major Swap Participants Reporting of all swaps 4
What is Clearing? Source: ICE 5
Clearing Basics: Elements of Central Clearing Elements of Central Clearing Central clearing involves submission of trades to a central counterparty ("CCP") Parties have credit exposure to CCP, not each other CCP will require that clearing members collect initial and variation margin from their customers Clearing members may set "house" margin requirements above CCP requirements Margin also collected by CCP from clearing members Initial margin used (collateral against market risks) is retained by CCP Variation margin (based on daily price changes) is paid by or to the CCP, which is overall flat Clearing members required to contribute to a guaranty fund and are subject to certain financial resources requirements Portability of trades (both pre- and post-default) 6
Clearing Basics: Agency and Principal-to-Principal Clearing; Indirect Clearing European Model US Model Clearing House Clearing House EU Clearing Member FCM Clearing Member "Client" (may be an affiliate) "Client" (may be an affiliate, e.g. European affiliate) Indirect Client Indirect Client (note: no privity) 7
Current State of Play Mandatory clearing (IRS, index CDS) and reporting began in 2013 (all swaps) Mandatory exchange trading (IRS, index CDS) began in February 2014 US Regulation of Derivatives Swap dealer registration/regulation/documentation and business conduct requirements in effect SEF registration commenced in October 2013 (exemptions available for certain EU MTFs) CFTC issued guidance on cross-border issues (currently subject to legal challenge) Most rules for security-based swaps still to come 8
Current State of Play Risk mitigation requirements mostly in force and deadline for acceding to ISDA protocols (September 2013) Reporting of all trades to trade repository since February 12, 2014 EU Regulation of Derivatives CCPs have re-applied for recognition decisions before June 2014 ESMA to submit final draft RTS on clearing obligation by September 15, 2014 Issues on extraterritoriality are being considered and addressed to an extent by regulators 9
Overview Dodd-Frank Requirements in Effect Registration: Swap Dealers and Major Swap Participants ("MSPs") currently must register with the CFTC Regulatory and Real-time Public Reporting: Swap Dealers, MSPs and other market participants must comply with various real-time and regulatory reporting requirements External Business Conduct: External business conduct rules (customer protection rules that require adherence to the ISDA August 2012 DF Protocol or bilateral equivalent) became effective May 1, 2013 Swap Trading Relationship Documentation: Swap trading relationship documentation requirements (which require adherence to the ISDA March 2013 DF Protocol or bilateral equivalent) became effective July 1, 2013 Portfolio Reconciliation: Swap Dealers and MSPs were required to comply with portfolio reconciliation requirements as of August 23, 2013 (ISDA March 2013 DF Protocol includes terms to address such requirements) Mandatory Exchange/SEF Trading: Certain credit and rates swaps must be traded on an exchange or swap execution facility ("SEF") All platforms falling within the SEF definition were required to register as SEFs by October 2, 2013, or cease operations Cross-Border: CFTC published its interpretive guidance on July 26, 2013, detailing how Dodd-Frank swaps requirements will apply to cross-border activities; SEC recently proposed a rule on same topic with respect to security-based swaps 10
Overview Future Dodd-Frank Rulemaking Many SEC Rules: The SEC needs to finalize many of its rules for security-based swaps ("SBS") rules. Most of these overlap with CFR rules (e.g. CDS) Margin for Uncleared Swaps: The Final Framework of the BSBC-IOSCO Consultation on Uncleared Margin, which is intended to promote harmonization of margin rules across the G-20, was issued on September 2, 2013 CFTC, SEC and Prudential Regulators are expected to issue revised rule proposals on margin requirements to incorporate terms of the Final Framework Final Framework provides for a phased-in implementation over four years starting December 1, 2015 and becoming permanent after December 1, 2019 New Capital Requirements for swap dealers: Timing for final rules uncertain; implementation is largely driven by Basel effort 11
Evolving Issues International coordination and extraterritorial applicability Which transactions will have to be cleared? Where does a transaction have to be cleared? Multiple different clearing requirements (e.g. transaction between US bank and EU bank)? Where does a transaction have to be traded? How can market participants access clearing houses in different jurisdictions? How are trading markets in different jurisdictions accessed? Cross-border recognition of clearing houses and trading facilities? 12
Clearing Obligation - EU EU Clearing Obligation "Financial counterparties" - Investment firms, banks, insurers, UCITS and their managers and funds managed by AIFMs Non-financial counterparties others (non-regulated corporates) End user/hedging exemption For transactions objectively measurable as reducing risks directly relating to the commercial activity or treasury financing activity of the non-financial counterparty or its group Derivatives designated for mandatory clearing, as declared by ESMA Pension funds delay until August 2015 Intragroup transactions (non-hedging) exemption subject to notification Scope of clearing obligation yet to be determined 13
Clearing Obligation - US CFTC released its first Mandatory Clearing Determination on November 28, 2012, requiring mandatory clearing for certain classes of interest rate swaps and credit default swaps Requirement commenced in 2013 IRS classes Fixed-to-floating swaps Basis swaps Forward rate agreements CDS classes USD-denominated untranched CDS indices referencing North American corporate credits Euro-denominated untranched CDS indices referencing European corporate credits Overnight index swaps Exception for non-financial end-users engaged in hedging transactions 14
Documentation for Clearing & Inter-relation between EU and US Documentation
US-style documentation: Cleared vs. Uncleared Swaps Cleared Swaps Both Uncleared Swaps Futures Agreement OTC cleared addendum FIA/ISDA form (product/clearinghouse neutral) Give-up agreement (FIA/ISDA execution agreement) Potential master netting arrangement to net futures, cleared and uncleared swaps SEF access DF Protocol Swap Dealer must comply with Business Conduct rules when they face a customer for a swap, whether it is to be cleared or not (exception for anonymous transactions) ISDA Master Agreement Schedule Credit Support Annex If segregation of IA is elected, then Account Control Agreement with third party custodian and CSA amendments 16
Documentation Suite for US Cleared Derivatives Futures Agreement FIA/ISDA Cleared Derivatives Addendum FIA/ISDA Execution Agreement SEF Access Arrangements Membership Agency Execution/Sponsored Access 17
Futures Customer Account Agreement Overview Designed for exchange-traded futures and options Typically not negotiated Not standardized Each FCM has its own version, often with nuanced differences Relevant because the provisions of the futures agreement will apply to the extent they are not addressed by the OTC Addendum 18
Futures Customer Account Agreement Key Provisions Typical Futures Agreement addresses: Parties to the futures agreement Agreement to act as broker Representations and warranties; FCM financial information Margin Payment Obligations and Timing The FCM may set and increase margin requirements over and above clearing house requirements Events of Default and Liquidation of Positions Objective vs. Subjective Events of Default Cure periods for events of default 19
Futures Customer Account Agreement Key Provisions Typical Futures Agreement (cont.): Acceptance of Orders and Position Limits Security Interests Cross-collateralization Termination Rights Portability/Transfer of Positions and Collateral 20
FIA/ISDA Cleared Derivatives Addendum Overview Purpose To supplement the terms of a futures agreement between an FCM and its customer to allow for the clearing of swaps Necessary because futures clearing agreements typically do not expressly cover cleared swaps Clearing of swaps can present unique issues FIA Addendum is generic in nature and is expected to replace any DCO-specific addenda Scope All swaps, forwards, options or similar transactions (whether executed in the OTC market or traded on a SEF or a DCM) that are submitted to and accepted for clearing by a clearing organization 21
FIA/ISDA Cleared Derivatives Addendum Key Provisions Typical OTC Cleared Derivatives Addendum: Definitions Covered Transactions: cleared swaps executed OTC or on execution facility Representations and Covenants of Clearing Member and Customer Applicable Law (including DCO/SEF rules) Transactions Not Accepted for Clearing Limitation of Liability Transfer of Positions (i.e., "portability") NFA Rule 2-27 Events of Default/Liquidation Section 7 Tax Provisions Schedule Parties can customize to make additional representations or other modifications to the OTC Addendum 22
Europe ISDA/FOA OTC Addendum and FOA Clearing Module ISDA/FOA OTC Addendum Can be added to an ISDA Master Agreement, futures clearing agreement, prime brokerage agreement or other similar agreement Intended to govern the relationship between buyside participants and clearing broker, principally for OTC derivatives Document can be used for exchange traded derivatives, but does not reflect market practice for futures and options FOA Clearing Module Drafted primarily with exchange-traded derivatives in mind but can be amended to document an OTC clearing relationship Enables firms to clear both listed and OTC derivatives Can be used with the FOA's standard exchangetraded derivatives clearing agreement. Does not reflect market practice for OTC derivatives, but product seems to be moving to more futures-style approach 23
Common to ISDA/FOA OTC Addendum and FOA Clearing Module Terms related to role of clearing member as "intermediary" Automatic pass-through of terms of cleared contract Automatic pass-through of CCP performance Ability to pass-through effect of actions under cleared contract by CCP Clearing member and client termination rights? Limitation of Liability Of clearing member to client in relation to performance or non-performance of CCP or related system Indemnity From client to clearing member for losses incurred with client transactions at CCP 24
Common to OTC Addendum and Clearing Module Pre-default portability Right of client to transfer positions pre-default of clearing member to back-up clearing member(s) Pre-default porting right subject to certain conditions relating to collateral, conditions of relevant CCP, applicable law and any other condition parties agree Set-off/netting Restricts set-off by client following a clearing member default 25
The ISDA/FOA OTC Addendum and the FOA Clearing Module CCP default Clearing Member default Customer default Only relevant to cleared transactions o o o o o Generally, pass-through by clearing member of what it receives Termination of back-to-back transactions for the relevant CCP service, at the same time as the CCP transactions terminate Valuation of transactions should match CCP valuations under its CCP insolvency and default rules Any porting to another CCP under CCP resolution rules or law should therefore be available Limited recourse payments, depending on extent of clearing member's claim For cleared transactions, definition aligned with declaration of default under CCP rules o o o Termination of back-to-back transactions for the relevant CCP service, at the same time as the CCP transactions terminate Valuation of transactions should match CCP valuations under its CCP insolvency and default rules Porting to a solvent clearing member under CCP rules available May be some additional defaults but query remedy For uncleared transactions, same as under existing agreement Generally, as under existing OTC master agreements Clearing member needs to manage close-out of corresponding transactions at CCP Valuation of trades requires close-out values of back-to-back cleared trades and any related hedging to be taken into account 26
General differences between ISDA/FOA Addendum and FOA Module ISDA/FOA OTC Addendum Sits on top of an ISDA master agreement two sided credit agreement Negotiated agreement balanced FOA Module Sits on top of a one-sided futures clearing agreement where clearing member is intermediary Many mutual provisions made one-sided. Various protections for clients Credit exposures on both sides considered Many protections for clients deleted Mainly concerned about credit risks to the clearing member 27
Specific differences between ISDA/FOA Addendum and FOA Module ISDA/FOA OTC Addendum FOA Module Margin and collateral provisions based on ISDA/CSA form Provisions suited to title transfer arrangements Various options for negotiation and bespoke agreement (e.g. liability, increased costs, termination of services for particular CCPs, re-use of collateral, CCP collateral matching) Margin and collateral provisions based on FOA form Client money / client asset arrangements facilitated explicitly in FOA Module (as well as title transfer collateral) FOA Module is more "one size fits all" More extensive and exhaustive agreement generally, covering many plain vanilla aspects of clearing Many boilerplate issues already in base FOA documents instead (e.g. liability, indemnities, confidentiality) 28
Specific differences between ISDA/FOA Addendum and FOA Module ISDA/FOA OTC Addendum "Modification Event" provisions of ISDA/FOA Addendum: highly complex provisions on when pass-through of certain amendments at CCP level may not occur. Clearing member and client bound by CCP rules. Lengthy tax provisions. ISDA/FOA allows withholding for some reporting failures by clearing member, for example. FOA Module Cleared contracts and client trades are required to be equal at all times. No agreement by clearing member to be bound by CCP rules. Creates a compliance issue with some CCP rules. Tax provisions (e.g. withholding) are more one-sided in FOA Module, favoring the clearing member. More detailed (more robust?) close-out netting provisions. Shorter shrift to close out netting. ISDA legal opinion set plus CCP opinions. FOA legal opinion set plus CCP opinions. 29
Reporting and Conduct of Business Requirements
Mandatory reporting under EMIR February 12, 2014 - obligation came into effect for all counterparties to report all derivative contracts (OTC and exchange-traded) to a trade repository TERMINATED BEFORE AUGUST 16, 2012 TERMINATED BEFORE FEBRUARY 12, 2014 LIVE ON FEBRUARY 12, 2014 Entered into on or after August 16, 2012 N/A February 12, 2017 February 12, 2014 Entered into before August 16, 2012 No reporting obligation February 12, 2017 May 13, 2014 Obligation generally applies only to EU counterparties Obligation applies separately to each counterparty Reporting to take place no later than the next day following the conclusion, modification or termination of a derivative contract Counterparties to maintain records of their derivative contracts for five years after termination From August 12, 2014 - FCs and NFC+s required to provide daily reports to trade repositories of mark-to market/mark-to-model information of all reportable derivative contracts and collateral information Information in trade repositories visible only to reporting counterparties, repositories and regulators 31
Legal Entity Identifier (had to be obtained pre-february 12, 2014) FOR EU HEDGE FUNDS Obtain a LEI for itself and notify this to counterparties Obtain a LEI from each of its counterparties Report all derivative contracts to a trade repository. Reporting can be delegated if the counterparty agrees, otherwise the fund manager needs to be a member of (have access to) a trade repository. Accede to the ISDA 2013 EMIR Portfolio Reconciliation, Dispute Resolution and Disclosure Protocol as published by the International Swaps and Derivatives Association, Inc. ("ISDA") on July 19, 2013 (the "ISDA EMIR Protocol") FOR A NON-EU HEDGE FUND DEALING WITH EU COUNTERPARTIES Obtain a LEI for itself and notify this to counterparties No obligation to report the derivative contract. The EU Counterparty will be obliged to report its side of the derivative contract Accede to the ISDA 2013 EMIR Portfolio Reconciliation, Dispute Resolution and Disclosure Protocol as published by the International Swaps and Derivatives Association, Inc. ("ISDA") on July 19, 2013 (the "ISDA EMIR Protocol") FOR A NON-EU HEDGE FUND DEALING SOLELY WITH NON-EU BANKS No action is required by the non-eu hedge fund or non-eu bank 32
Risk Mitigation EU Account Segregation at both CCP and clearing member level: Omnibus client segregation Individual client segregation US Account Segregation: New "LSOC" segregation requirements for swap customer positions and margin Margin: Margin levels must be sufficient to cover the losses that result from at least 99.5% of exposure movements for OTC derivatives. The change in confidence levels could potentially increase initial margin requirements 33
Risk Mitigation - EMIR Since March 15, 2013 EMIR requires: All counterparties formalized procedures for timely confirmation, where available electronically, of the terms of the OTC derivative contract FCs and NFC+s: mark-to-market/model their outstanding non-cleared OTC derivative contracts on a daily basis FCs: hold "a proportionate amount of capital" to manage the risks not covered by appropriate exchange of collateral. Unclear what this adds to Basel/CRR Since September 15, 2013 EMIR requires: All counterparties: procedures to reconcile portfolios, manage associated risk and identify and resolve reconciliation disputes All counterparties with 500 or more non-cleared OTC derivative contracts with a single counterparty: portfolio compression (twice annually) 34
US External Business Conduct Rules CFTC External Business Conduct Standards for Swap Dealers Swap Dealers must comply with duties toward swap counterparties Prohibition on fraud, manipulation and abusive practices KYC requirements for CPs Verify eligibility for CPs to trade Disclose material information about the swap Scenario analysis and daily marks Protect confidential CP information and comply with fair dealing standards Effective since May-June 2013 35
Documentation and Risk Mitigation US Confirmation requirements Swap trading relationship documentation requirements Portfolio reconciliation requirements Effective July December 2013 ISDA Dodd-Frank Protocols August 2012 March 2013 36
Extraterritoriality of US and EU measures
Extraterritoriality Both EMIR and Dodd-Frank apply extraterritorially global nature of the derivatives market creates potential for conflict and overlap Cases of Potential Conflict Transaction between US and EU entity Where does it have to be cleared? Where does it have to be traded? Where does it get reported? Which conduct of business rules apply? Which regulator does the supervision? Where is a party located? Funds? Guaranteed entities and "conduits" Group structures 38
Extraterritoriality Clearing and Transaction Reporting EMIR Clearing The EMIR clearing obligation extends outside the EU to OTC derivatives contracts entered into by non-eu entities where: They enter into a contract with a EU counterparty that would have been subject to EMIR, were they established in the EU; or "Direct, substantial and foreseeable effect" in the EU; or An anti-evasion measure US clearing obligation extends to a transaction with a US person as well as certain transactions between non-us persons where there is a US connection Reporting and conduct of business Reporting requirements in both EU and US apply to US-EU transactions two separate reports often required Reporting fields under CFTC rules and ESMA technical standards differ in detail; Confidentiality requirements and regulator access not fully aligned Conduct of business: often both sets of rules will apply to international transactions 39
Extraterritoriality Trading US US requires a platform meeting the SEF definition to register where one or more participants is a US person Swaps subject to mandatory trading must be executed on a SEF where one party is a US person (and in certain other cases) CFTC Staff provided guidance that a platform must register as a SEF if it permits persons located in the US to trade or execute swaps, even on behalf of non-us persons CFTC has provided no-action relief for qualifying EU MTFs from the SEF registration requirement Trading on such MTFs satisfies the US mandatory trading requirement CFTC contemplating a more formal exemptive relief process for foreign platforms 40
Extraterritoriality Trading - EU MiFID/MiFIR: Derivatives will in future be traded on regulated markets, multilateral trading facilities ("MTFs"), organized trading facilities ("OTFs") or an equivalent third country trading venue ESMA to prepare final draft technical standards on the derivative contracts subject to this obligation and the date from which the obligation will take effect Class of derivatives must be sufficiently liquid Trading obligation will apply to financial counterparties, non-financial counterparties (above the clearing threshold) and non-eu counterparties subject to the clearing obligation under EMIR Earliest likely applicable date is late 2016 41
Extraterritoriality Key Issues Most EU clearing houses are dual-registered as CFTC-registered derivatives clearing organization (DCO) and authorized or recognized as a central counterparty (CCP) under EMIR Most US clearing houses have applied for EU third country CCP status However, significant legal and operational issues remain, such as differing requirements on margin and segregation, rulebook approval processes But EU or US trade repository is dual-regulated or subject to equivalence/substituted compliance: overlap/duplicative reporting taking place Market solutions are emerging - DTCC will offer reporting for both EU and US purposes through technology interfaces which report to its US and EU repositories Substituted compliance/equivalence may mitigate some of the risks of conflict and overlap But, no equivalence determinations have so far been made by the EU Commission Broker/MTFs now will face similar uncertainties under MiFID II 42
Extraterritoriality under EMIR EU Entity (including Branches established in Third Countries) Equivalent Third Country (including Branches established in Third Countries) Non-Equivalent Third Country EU Branch Third Country Entity EU Entity (including Branches established in Third Countries) Clearing, reporting and risk mitigation required Clearing, reporting and risk mitigation required Clearing, reporting and risk mitigation required Non- Equivalent Third Country EU Branch Third Country Entity Clearing, reporting and risk mitigation required Clearing, reporting and risk mitigation required Clearing, reporting and risk mitigation not required ('deemed' to be complied with) Clearing and risk mitigation required Clearing and risk mitigation required only if substantial guarantee from EU Financial Counterpart 43
Transatlantic differences US v EU Customer Segregation The EU requires the choice to be offered between full customer segregation or an omnibus account: It is currently possible to offer US customers LSOC in the form of an omnibus account; It may not be possible to offer US customers full individual segregation, as FCMs must use LSOC, and Bankruptcy Code issues arise on individual segregation The US requires FCMs to segregate initial customer margin using LSOC: Customer assets are protected from fellow customer risk, but Customers are subject to pro-rata sharing if there is a shortfall from investment or custodial loss This gives rise to discrepancies in customer protection when EU clearing houses, or EU-recognized clearing houses, are used by US entities 44
Trans-Atlantic Differences Margin Requirements Cleared swaps and futures Current EU requirement is to calculate margin using a minimum two-day liquidation assumption for cleared derivatives, with a possible top-up for proportionality purposes CFTC requires a minimum one-day liquidation assumption for futures and agricultural/energy swaps; this will be a lot cheaper Eligible collateral requirements may also differ under US rules, letters of credit are not acceptable for swaps; under EMIR, letters of credit and bank guarantees are acceptable for non-financial counterparties Uncleared swaps Under CFTC's proposed margin rules, uncleared swaps are subject to margin requirements at least as stringent as for cleared swaps Final rules have been delayed pending IOSCO consultation EU has yet to propose specific technical standards on margin for uncleared swaps 45
CFTC and European Commission Joint Statement on Progress Update Announcement on February 12, 2014 on progress relating to the implementation of the 2013 Path Forward Statement CFTC issued two no-action letters which: exempt certain EU-regulated multilateral trading facilities ("MTFs") from registering as Swap Execution Facilities ("SEFs"); exempt parties executing swaps on MTFs from the trade execution requirement; and provides relief to swap dealers and major swap participants executing swap transactions on qualifying MTFs from certain requirements under the CFTC's business conduct rules 46
QCCP Issues
New Rule Regulating Exposures to Clearing Houses Lower regulatory capital weightings now available for exposures to Qualifying Central Counterparties ("QCCPs") Economically significant difference 2% or 4% for QCCP Exposure (higher for non- QCCPs); 0% for collateral held on insolvency remote basis Significantly lower risk weights for guarantee fund contributions to QCCPs than non-qccps 0% for clearing members and clients offering indirect clearing when acting as a limited recourse financial intermediary for a QCCP 48
What is a QCCP? Basel III Qualifying Central Counterparty CCP regulated by regulator that applies CPSS-IOSCO Principles (and publicly states that it applies those Principles) Mathematical test financial resources (size & quality) v. counterparty credit risk exposures 49
Implementation is Not Uniform, Especially for Non-Domestic QCCPs Some countries look only to regulation in a country that follows the CPSS-IOSCO Principles Some countries have additional local information requirements Some countries have additional local regulatory registration or equivalence requirements 50
Rules on QCCPs European Capital Requirements Regulation A CCP that has been authorised or recognised under EMIR is a QCCP An EU or third-country CCP can be considered a QCCP by banks until June 15, 2014 or its application for authorisation under EMIR has been decided European Commission may extend the operation of the transitional measures by six months in exceptional circumstances UK PRA: Transitional Recognised CCPs and overseas CCPs which had access to the UK pre-emir can be treated as QCCPs US Rules Includes designated financial market utilities under Dodd-Frank (also called systemically important derivatives clearing organizations, or "SIDCOs") Includes CCPs that have elected to become "subpart C" derivatives clearing organizations under CFTC rules If not located in the US, a QCCP must meet standards established under the law of its home country that are consistent with the CPSS-IOSCO Principles 51
EMIR Update Adam Jacobs Alternative Investment Management Association March 2014 Enhancing Understanding, Sound Practices and Industry Growth 52
About AIMA Over 1,400 member firms worldwide Over 7,000 individual member contacts Members in over 50 countries Over 1,300 contacts among regulators and policymakers Over 600 institutional investor contacts Over 900 media contacts Enhancing Understanding, Sound Practices and Industry Growth 53
Membership Profile Members by firm type 8% 7% 11% 4% 8% Managers 50% Fund of funds managers Lawyers Fund Administrators Accountants/Auditors Prime brokers Members by region 27% 47% 26% 13% Consultants/others Americas Asia Pacific EMEA Membership by manager (by number) Manager members (by Regional AUM) 47% 28% 48% 25% 44% 8% Americas Asia Pacific EMEA Data as at February 2014. These numbers are estimates. Americas Asia Pacific EMEA Enhancing Understanding, Sound Practices and Industry Growth 54
Government & Regulatory Affairs Specialised department provides members with guidance notes and updates on relevant regulatory developments Dedicated teams for Asset Management Regulation, Markets Regulation and Tax Affairs Responds to regulatory and tax consultations worldwide seeking to bring change that helps the industry Meets regularly with senior policymakers, legislators and regulators in all important jurisdictions Engagement supported by public affairs consultants on the ground in the main financial and political centres Enhancing Understanding, Sound Practices and Industry Growth 55
EMIR Stock Take August 2012: Entry into force of primary legislation Key elements currently live: Non-margin risk mitigation requirements for non-cleared trades: Including timely confirmation (from March 15, 2012) and portfolio reconciliation, portfolio compression of trades (from September 15, 2012). Reporting: ETD and OTC reporting for all asset classes started on February 12, 2014. Future developments: Clearing Obligation: Product mandates not anticipated until Q4 2014 at earliest. Margin for non-cleared trades: Consultation process to kick off Q2/Q3 this year. Extraterritorial provisions - "direct, substantial effect"/anti-evasion: Standards have been endorsed by European Commission awaiting publication. Enhancing Understanding, Sound Practices and Industry Growth 56
EMIR Scope Financial counterparty: Entities subject to EU financial services regulation: MiFID investment firms (cf. US broker dealers); banks; (re)insurers; UCITS funds / management company; occupational pension funds; AIF managed by a manager authorised under the AIFMD Non-financial counterparty: Any other entity established in the EU (except CCPs and TRs). Distinction between NFC- and NFC+ (above clearing threshold) 'Third-country entity' AIMA analysis: Manager AIF Non EU EU EU AIFM Pre July 2014: Third country entity. Post July 2014: FC Pre July 2014: NFC Post July 2014: FC Non EU AIFM Pre October 2015: Third country entity Post October 2015*: FC Pre October 2015: NFC Post October 2015*: FC * October 2015 at the earliest Enhancing Understanding, Sound Practices and Industry Growth 57
EMIR obligations by counterparty Clearing Risk mitigation Reporting FC Yes Yes Yes NFC No Yes* Yes** NFC + Yes Yes Yes TCE Yes*** No**** No * Only timely confirmation, dispute resolution, portfolio reconciliation and compression ** Per above, not required to report daily mark-to-market of OTC derivative exposures (or to mark-to-model where market conditions prevent marking to market) *** Provided (i) counterparty an FC or NFC+, and TCE would have been an FC or NFC+ if it had been established in the EU or (ii) where both counterparties are TCEs that would have been FCs or NFC+s if they had been established in the EU (provided that the contract has a direct, substantial and foreseeable effect within the EU or where it is necessary or appropriate to prevent the evasion of any provisions of EMIR) **** Unless TCE would have been an FC or NFC if it had been established in the EU and the contract has a direct, substantial and foreseeable effect within the EU or where it is necessary or appropriate to prevent the evasion of any provisions of EMIR Enhancing Understanding, Sound Practices and Industry Growth 58
Additional challenges / areas of uncertainty Classification of FX Definition of "derivative" under EMIR relies on MiFID Lack of consistency as some EU Member States define derivative differently with respect to FX (spot/forward) e.g., FCA (UK) - commercial/investment purpose test cf. CBI (Ire) - reference to settlement length only (with exceptions made re market standard) Confusion as to what was considered in scope for EMIR reporting Reporting/TR on-boarding issues Surprise inclusion of ETDs from February 12, 2014 (not January 2015 pursuant to ESMA advice) Above compounded by numerous delays with TR on-boarding process ISDA Delegated Reporting Agreement Significant negotiation required for buy-side? AIMA has worked with the CBI, CSSF (Lux) and FCA on communicating the likely enforcement approach to our hedge fund manager members Cross-border dynamic Interaction between EMIR and CFTC US person definition AIMA CFTC relief request Enhancing Understanding, Sound Practices and Industry Growth 59
Discussion Enhancing Understanding, Sound Practices and Industry Growth 60
Speakers Thomas Donegan London T +44.(0).20.7655.5566 thomas.donegan@shearman.com Geoffrey Goldman New York T +1.212.848.4867 geoffrey.goldman@shearman.com Adam Jacobs AIMA T +44.(0).20.7822.8392 ajacobs@aima.org Barnabas Reynolds London T +44.(0).20.7655.5528 barney.reynolds@shearman.com 61