- On 31 December 2020 at 11pm, the UK ceased to be a part of the European Financial Space (EEA).
- Previous to the above date, regulation of UK derivatives actions in lots of circumstances arose on account of EU laws which was immediately relevant within the UK, for instance the European Market Infrastructure Regulation (Regulation (EU) No. 648/2012, as amended and the related delegated laws (EU EMIR).
- For essentially the most half, EU EMIR and different comparable laws affecting derivatives exercise (and the related delegated laws) have been on-shored within the UK by the European Union (Withdrawal) Act 2018 (EUWA), as amended.
- Though this laws broadly follows the equal EU guidelines, care is required as there are particular variations between them and there can be circumstances the place counterparties will now must adjust to two regimes. Future divergence can be potential and maybe possible.
- Beneath are some sensible concerns that derivatives counterparties ought to take into consideration when buying and selling derivatives transactions within the EU and UK, together with when it comes to the impression on documentation.
EU EMIR: Short-term recognition of UK clearing homes
UK based mostly clearing homes now require an equivalence resolution from the European Fee (EC) as a way to be recognised by EU regulators as central counterparties (CCPs) beneath EU EMIR. Within the absence of equivalence, UK-based CCPs usually can’t be used to clear derivatives transactions which can be topic to the clearing obligation beneath EU EMIR. Though no everlasting equivalence resolution has been made by the EU in respect of UK-based CCPs, momentary preparations have been put in place, which permit counterparties to over-the-counter (OTC) derivatives transactions to proceed utilizing sure UK-based CCPs for a restricted interval till 30 June 2022.
UK EMIR: Recognition of EU clearing homes
Equally to the above, beneath EU EMIR as on-shored within the UK pursuant to EUWA (UK EMIR), all OTC derivatives topic to the UK clearing obligation should be cleared by a UK authorised CCP or a CCP recognised by the Financial institution of England. Recognition can solely be granted to CCPs in jurisdictions that HM Treasury has declared to be equal to the UK EMIR regime. HM Treasury has made an equivalence resolution in respect of EEA states, together with EU states, and so particular person EU CCPs could also be granted full recognition beneath UK EMIR, though it is a prolonged course of. Within the meantime, the Financial institution of England has launched a short lived recognition regime that permits EEA CCPs that apply for recognition to proceed to clear by-product transactions for 3 years (which could be prolonged). Because of this UK counterparties which can be topic to UK EMIR can proceed to clear their OTC derivatives transactions by EEA CCPs for 3 years and this can be prolonged additional.
EU Derivatives Buying and selling Obligation
As from 1 January 2021, EU-based counterparties are not capable of fulfill their buying and selling obligation for OTC derivatives beneath Regulation (EU) 600/2014 (MiFIR) (EU DTO) by buying and selling on UK buying and selling venues. The EU DTO applies to (i) EU-based counterparties which can be monetary counterparties (FCs) and non-financial counterparties (NFCs) above the clearing threshold (NFC+s) beneath EU EMIR when buying and selling in-scope OTC derivatives between them and (ii) FCs and NFC+s when buying and selling in-scope OTC derivatives with third-country entities that may be topic to the EU DTO in the event that they have been established within the EU.
OTC by-product transactions topic to the clearing obligation beneath EU EMIR are usually throughout the scope of the EU DTO.
UK Derivatives Buying and selling Obligation
Below UK EMIR, UK corporations which can be topic to the UK derivatives buying and selling obligation (UK DTO) need to commerce sure liquid derivatives on a UK buying and selling venue. Nevertheless, the UK has offered transitional aid for 3 months so the UK DTO won’t apply in sure circumstances the place UK corporations are buying and selling with EU corporations topic to the EU DTO. This aid is to be reviewed by the Monetary Conduct Authority (FCA) by 31 March 2021, though there isn’t a indication that the FCA will essentially change its method.
EU EMIR: Characterisation of derivatives traded on UK regulated markets as OTC derivatives
EU EMIR defines OTC derivatives as derivatives that aren’t executed on a regulated market or a third-country market decided by the EC to be equal to a regulated market in accordance with the method laid out in EU EMIR. Within the absence of any equivalence resolution taken by the EC with respect to UK regulated markets, derivatives traded on UK regulated markets and entered into on or after 1 January 2021 can be thought-about to be OTC derivatives for the needs of figuring out whether or not EU-based counterparties are FCs that exceed the clearing threshold (FC+s) or NFC+s and whether or not third nation entities, which now consists of UK-based counterparties), would qualify as FC+s or NFC+s in the event that they have been established within the EU (equal FC+s or equal NFC+s, respectively).
Such re-characterisation of exchanged traded derivatives to OTC derivatives beneath EU EMIR will have an effect on the clearing threshold calculations, that are used to find out counterparties’ standing (i.e. FCs, FC+s, NFCs, NFC+s, equal FC+s and equal NFC+s) as a way to verify which clearing and margin necessities will apply to by-product transactions concluded by counterparties. The inclusion of derivatives traded on UK regulated markets within the calculation of clearing thresholds beneath EU EMIR may in some circumstances result in the next opposed penalties:
- a counterparty being handled as an FC+ or a 3rd nation entity being handled as an equal FC+, leading to its transactions being topic to necessary clearing beneath EU EMIR and to the EU DTO;
- a counterparty being handled as an NFC+ or a 3rd nation entity being handled as an equal NFC+, leading to its transactions being topic to necessary clearing beneath EU EMIR and to the EU DTO or to margining obligations beneath EU EMIR; and
- on account of a counterparty being handled as an NFC+, the counterparty not having the ability, when concluding by-product transactions with an FC, to depend on the regulatory requirement for the FC to report these transactions for each events beneath EU EMIR.
UK EMIR: Characterisation of derivatives traded on EU regulated markets as OTC derivatives
Equally, derivatives which can be executed on an EU regulated market are in scope of the definition of “OTC by-product” beneath UK EMIR. Nevertheless, HM Treasury has made an equivalence resolution in respect of EEA states, which permits UK corporations to proceed to deal with derivatives traded on EEA regulated markets as exchange-traded derivatives relatively than OTC derivatives and exclude them from the calculation.
Below UK EMIR, all UK FCs and NFC+s should ship a clearing threshold notification to the FCA by 17 June 2021. This new notification is required even when the UK FC or NFC has already submitted a clearing threshold beneath EU EMIR. For these corporations which can be already topic to the clearing obligation, this notification can be just like the one-off notification that was despatched to the FCA and the European Securities and Markets Authority (ESMA) in June 2019.
Counterparties ought to verify whether or not there may be any change to their current representations as to their classification standing beneath the relevant EU EMIR or UK EMIR regime and consequently, whether or not any insurance policies and documentation have to be up to date within the occasion of a change of counterparty classification. ISDA has printed a revised ISDA Grasp Regulatory Disclosure Letter, together with a brand new UK Appendix, which counterparties can use to speak sure info together with their classification standing beneath EU EMIR and/or UK EMIR.
EU EMIR: Clearing exemption for pension funds
Sure EU pension schemes have benefited from a short lived exemption from the clearing obligation beneath EU EMIR the place they enter into derivatives transactions which can be objectively measurable as lowering funding dangers immediately referring to the monetary solvency of that pension scheme. From 1 January 2021, UK-based pension schemes have not benefitted from this exemption beneath EU EMIR.
UK EMIR: Extension of pension scheme exemption
So far as the UK EMIR regime is anxious, HM Treasury has prolonged the exemption for sure pension schemes till 18 June 2023 and each UK and EU pension schemes are throughout the scope of the exemption in order that trades between UK entities and EU entities won’t need to be cleared beneath UK EMIR throughout that point. The FCA maintains an inventory of the forms of pension schemes which have been granted an exemption.
EU EMIR: Clearing and margining exemptions for intragroup transactions
Current intragroup exemptions associated to clearing and margining obligations beneath EU EMIR (which have been prolonged till 30 June 2022) have ceased to use for by-product transactions between UK-based and EU-based affiliated entities. Up to now, the EC has not adopted an equivalence resolution declaring that the UK regime is equal for the needs of the EMIR necessities in respect of clearing and/or margining, as relevant. EU-based counterparties coming into into OTC derivatives with their UK-based associates could also be required to clear, or to change margin in relation to, these transactions.
UK EMIR: Clearing and margining exemptions for intragroup transactions
UK entities can proceed to profit from an intragroup exemption from the clearing obligation with third nation group entities which can be (i) in jurisdictions which have been declared equal beneath EU EMIR, (i.e. Japan or america because the EU equivalence choices have been on-shored within the UK) and (ii) in jurisdictions for which the associated exemptions beneath EU EMIR are grandfathered beneath UK EMIR for 3 years till 2024 (besides the place an equivalence resolution is made). UK entities that at the moment profit from intragroup exemptions relating to the clearing and margining necessities in respect of their by-product transactions with EU group counterparties should notify the FCA inside sure timeframes as a way to proceed to profit from these exemptions, following an HM Treasury equivalence resolution.
UK EMIR: The EU delegated Margin RTS is just not on-shored beneath the UK regime
On 18 February 2021, the EU delegated margin Regulatory Technical Requirements (RTS) entered into drive. The RTS embody the brand new preliminary margin phase-in dates (i.e. 1 September 2021 for section V and 1 September 2022 for section VI) and the exemptions from the margin necessities for fairness and index choices and bodily settled international change transactions.
Because the RTS entered into drive after the top of the Brexit transition interval, they don’t type a part of retained EU regulation within the UK. The UK Prudential Regulatory Authority (PRA) has not too long ago launched a joint session with the FCA to implement the revised margin phase-in dates and different amendments. In accordance with the session paper, the proposed modifications can be efficient on 1 July 2021. In its Coverage Assertion in December 2020, the PRA acknowledged the variations between the present UK guidelines and the revised EU margin guidelines (they have been in draft type) and stated that pending the result of this session, it would apply forbearance.
UK EMIR: Threat mitigation methods
Below UK EMIR, counterparties must adjust to sure danger mitigation methods (which mirror these beneath EU EMIR) in respect of their derivatives trades. Though the necessities beneath UK EMIR and EU EMIR are comparable, counterparties ought to verify that documentation refers to UK EMIR the place related and also needs to contemplate the confidentiality waiver within the context of UK EMIR.
UK entities might want to adhere to the ISDA 2020 UK EMIR Portfolio Reconciliation, Dispute Decision and Disclosure Protocol (UK EMIR Protocol), which is the UK on-shored model of the ISDA 2013 EMIR Portfolio Reconciliation, Dispute Decision and Disclosure Protocol (EU EMIR Protocol). This allows events to amend the phrases of their in-scope agreements to replicate the portfolio reconciliation and dispute decision necessities beneath UK EMIR and features a confidentiality waiver offering the events’ consent to the disclosure of data as required to assist events meet the varied reporting and report conserving necessities beneath UK EMIR. The place UK counterparties are buying and selling with EU counterparties, the EU EMIR Protocol may also proceed to use; adhering to the UK on-shored EMIR protocol won’t override or change the amendments beforehand made by the EU EMIR Protocol. Non-UK entities can also want to adhere to the UK EMIR Protocol if they’re buying and selling with a UK FC or UK NFC although they will not be immediately topic to the foundations themselves.
EU EMIR: Reporting of by-product transactions
As from 1 January 2021, if an EU entity transacts with a UK entity, there can be twin reporting beneath the UK EMIR and EU EMIR reporting regimes. EU-based counterparties ought to guarantee the continual reporting of their by-product transactions to a commerce repository established within the EU and registered beneath EU EMIR (EU TR) or a commerce repository recognised beneath EU EMIR (EU Recognised TR) as a way to adjust to their reporting obligations beneath Article 9 of EU EMIR. From 1 January 2021, UK-based counterparties should not anticipated to report any by-product transactions concluded on or after 31 December 2020, or any modification to by-product transactions concluded previous to 31 December 2020, to EU TRs or EU Recognised TRs. Moreover, UK-based counterparties are not answerable for the reporting of by-product transactions for sure of their EU counterparties beneath Articles 9(1a) to 9(1d) of EU EMIR. Whereas the UK was nonetheless thought-about an EU entity (i.e. up till 31 December 2020) (i) a UK-based FC needed to report for its EU-based NFC- counterparties and (ii) a UK fund supervisor needed to report on behalf of its EU funds (whether or not such managed funds have been AIFs (Different Funding Funds) or UCITS (Undertakings for the Collective Funding in Transferable Securities) funds). As from 1 January 2021, the EU-based counterparties within the eventualities above turned answerable for their very own reporting of derivatives transactions.
UK EMIR: Reporting of by-product transactions
Equally, UK entities in scope of UK EMIR must report new transactions entered into on or after 11 pm on 31 December 2020, in addition to any modifications or terminations of transactions after this date, to an FCA registered or recognised commerce repository (UK TR). There is no such thing as a transitional aid out there though the FCA has stated that it’ll act proportionately and, if corporations should not totally ready, enforcement motion won’t be initiated the place the agency has taken cheap steps to conform.
Counterparties which have delegated reporting preparations in place ought to contemplate whether or not these preparations have to be revisited and whether or not new reporting preparations ought to be put in place.
EU EMIR: Novation of by-product transactions to deal with Brexit associated points
To deal with challenges ensuing from the brand new standing established within the UK following Brexit, counterparties can novate current by-product contracts concluded with UK-based entities by changing the counterparty established within the UK with a counterparty established in an EU Member State. The substitute may set off the clearing obligation or the margining obligation beneath EU EMIR if it happens on or after the date from which the clearing obligation or, as relevant, the margining obligation takes impact for that sort of contract. With a purpose to guarantee the sleek functioning of the market and a stage enjoying discipline between counterparties established within the EU, Delegated Laws (EU) 2021/237 and (EU) 2021/236 of 21 December 2020 permit novation of by-product contracts for the aim of changing counterparties established within the UK with counterparties established in a EU Member State with out triggering the clearing obligation or the margining obligation beneath EU EMIR.
EU SFTR: Reporting of securities financing transactions
EU-based counterparties and EU branches of UK-based counterparties ought to guarantee the continual reporting of their securities financing transactions (SFTs) to an EU TR or an EU Recognised TR as a way to adjust to their reporting obligations beneath Article 4 of Regulation (EU) 2015/2365 (EU SFTR). From 1 January 2021, a UK-based commerce repository will not be an EU TR and counterparties will not be allowed to report back to UK-based repositories for the needs of EU SFTR except these UK-based repositories turn out to be EU Recognised TRs. Equally, UK-based counterparties should not anticipated to report any SFT entered into, modified or terminated on or after 31 December 2020 to EU TRs or EU Recognised TRs. Moreover, UK-based counterparties are not answerable for the reporting of SFTs for sure of their EU counterparties beneath Article 4(3) of EU SFTR, specifically (i) UK FCs not must report for EU-based NFCs under sure thresholds referring to the full of its stability sheet, its web income and its variety of staff and (ii) UK fund managers not must report on behalf of their funds (whether or not such managed funds are AIFs (Different Funding Funds) or UCITS (Undertakings for the Collective Funding in Transferable Securities) funds); in such conditions, the EU-based counterparties and EU branches of UK-based counterparties turn out to be answerable for the reporting of these SFTs.
UK SFTR: Reporting of securities financing transactions
EU SFTR has been on-shored into UK regulation (UK SFTR) and applies to the UK-based SFTR counterparties, UK branches of third nation FCs and third nation branches (together with EU branches) of UK-based FCs that enter into SFTs. Just like UK EMIR, UK SFTR requires these entities to report particulars of their SFTs to a UK TR. It’s price noting that while UK branches of EU corporations don’t must report their derivatives transactions to a UK TR beneath UK EMIR, they do must report their SFTs to a UK TR beneath UK SFTR. The reporting necessities beneath UK SFTR began to use from 31 December 2020 and there’s no transitional aid out there. Additionally it is vital to notice that the UK didn’t onshore the SFTR reporting obligation for NFCs and, subsequently, UK NFCs (together with EU branches of UK NFCs) don’t fall throughout the scope of the UK SFTR reporting regime.
Disclosure of quick promoting positions beneath Regulation (EU) 236/2012
From 1 January 2021, the notification necessities referring to the holding of web quick positions as set out in article 1 of Regulation (EU) 236/2012 (EU SSR) not apply to derivatives on shares which can be admitted to buying and selling within the UK however not within the EU or derivatives on UK sovereign debt.
Derivatives on shares admitted to buying and selling on each EU and UK buying and selling venues might turn out to be topic to quick place disclosure necessities beneath each EU and UK regulation, even when main buying and selling market is within the UK. Though EU nationwide competent authorities may decide that the principal buying and selling venue of such shares is within the UK i.e. exterior the EU (which decide would, as soon as efficient, lead to these shares and derivatives on these shares being excluded from the scope of the disclosure necessities beneath the EU SSR), such willpower will solely turn out to be efficient when ESMA updates its checklist of shares for which the principal buying and selling venue is situated in a 3rd nation. The checklist is efficient for a two yr interval and printed each two years.
UK regime: The EU SSR has been on-shored into UK regulation (the UK SSR) and applies to the quick promoting of sovereign debt, shares which can be admitted to buying and selling on a UK buying and selling venue (except exempt) and associated devices and using credit score default swaps. Holders of web quick positions in shares admitted to buying and selling on a buying and selling venue within the UK (except they’re exempt) or UK sovereign debt are required to make notifications to the FCA as soon as sure thresholds have been breached. If shares are admitted to buying and selling exterior the UK, they’re exempt from the notification and disclosure necessities.
Commodity derivatives and “ancillary exercise” exemption beneath Directive 2014/65/EU (EU MiFID II)
Entities dealing on personal account in commodity derivatives are exempted from the requirement to acquire a license as an funding agency beneath EU MiFID II, offered that their most important enterprise doesn’t include offering funding companies, performing funding actions, working the enterprise of a financial institution or performing as a market maker in commodity derivatives.
One of many exams to be complied with by such entities to ensure that them to find out that their exercise in commodity derivatives is ancillary to their most important enterprise is the general market threshold take a look at; this take a look at is carried out by evaluating the group’s commodity buying and selling exercise within the EU with the full commodity buying and selling exercise within the EU. Brexit will lead to UK commodity buying and selling exercise being excluded from each the numerator and denominator of the calculations for the needs of this general market threshold take a look at, which may in flip lead to some corporations ceasing to have the ability to depend on the ancillary exercise exemption or turning into capable of depend on that exemption for the primary time.
UK regime: Presently, there isn’t a specific rule beneath UK regulation that excludes any buying and selling exercise within the EU from the corresponding general market threshold take a look at.
Commodity derivatives and place restrict regime beneath EU MiFID II
EU MiFID II establishes a place restrict regime for all commodity derivatives contracts traded on buying and selling venues and economically equal OTC contracts (EEOTC contracts) to stop market abuse and help orderly pricing and settlement situations.
From 1 January 2021, commodity derivatives traded on UK venues are not aggregated with devices traded on EU venues and EEOTC contracts for the needs of compliance with the place limits regime beneath EU MiFID II.
UK regime: Place limits apply to commodity derivatives executed on UK buying and selling venues and in EEOTC contracts. In a press release printed on 2 October 2020, the FCA confirmed that it doesn’t contemplate commodity derivatives traded on buying and selling venues, whether or not within the EU or elsewhere, as EEOTC contracts so they won’t depend in direction of the UK commodity derivatives place restrict regime.
Market members will need to overview their contracts and maintain abreast of fixing regulatory developments within the EU and UK, together with any potential divergence between the 2 regimes. Specifically, we’d recommend that market members ought to monitor the expiry of any momentary and transitional reliefs that they’re at the moment making the most of and put in place plans to keep away from any cliff edge dangers that will happen when such reliefs expire.