One of the tools of financial management is derivatives, which refer to contracts in which payment provisions may be based on various factors such as currency exchange rates, interest rates and equity prices. The main purpose of derivatives is therefore to minimise risk in trading and increase the efficiency of financing.
Act No. 15/2018 (in Icelandic) on Derivatives, Central Counterparties, and Trade Repositories entered into force in autumn 2018. This brought Regulation (EU) 648/2012 of the European Union of 4 July 2012 (Markets Infrastructure Regulation, or EMIR) into legal force in Iceland.
The regulation, EMIR, includes requirements for trading in derivatives, both OTC derivatives and listed derivatives, in addition to laying down harmonised requirements for the organisation, working practices and management of central counterparties and derivative trade repositories. The aim of the regulation is to improve transparency and mitigate risk in derivatives markets.
Scope of the regulation
EMIR entered into force in the European Union on 16 August 2012 and has been implemented in phases. EMIR consists of Regulation (EU) 648/2012, as well as the Commission implementing regulation and derivative regulations that implement so-called technical standards. The technical standards can be Regulatory Technical Standards (RTS) or Implementing Technical Standards (ITS) and concern further implementation of the provisions of Regulation (EU) no. 648/2012.
The scope of the regulation is quite wide, but it affects parties within the European Economic Area (EEA), as well as parties outside the EEA who engage in derivatives trading with counterparties within the EEA. Thus the regulation includes not only requirements for financial undertakings, but also other parties in the market that engage in derivatives trading.
EMIR requirements for entities that enter into derivative contracts
EMIR places requirements on all counterparties in derivative contracts, including interest rate, currency, equity, debt and commodity derivative contracts to:
- report all information about derivatives to a trade repository,
- clear all OTC derivative contracts that are subject to clearing obligations with central counterparties, if they are subject to clearing obligations and
- exercise risk-mitigation techniques for all OTC derivative contracts that are not cleared by a central counterparty.
Counterparties and clearing threshold
When parties enter into a derivative contract, they become each other’s counterparties in the transaction. This applies to options, futures and swaps in currency, interest rates, debt instruments, commodities and shares, as well as all other types of derivative contracts. EMIR divides counterparties in derivative transactions into two categories, which are in turn divided into two subcategories:
- Financial Counterparties (FCs): These include investment firms, credit institutions, insurance companies, pension funds, mutual funds and their management companies, as well as Alternative Investment Fund Managers (AIFMs).
- Financial counterparties with aggregate positions in OTC derivatives subject to clearing over the clearing threshold referred to in Article 10 of the regulation (FC +)
- Financial counterparties with aggregate positions in OTC derivatives subject to clearing under the clearing threshold referred to in Article 10 of the regulation (FC or smaller financial counterparties)
- Non-financial counterparties (NFC): These include all those who do not fall under the definition of financial counterparties.
- Non-financial counterparties with aggregate positions in OTC derivatives subject to clearing over the clearing threshold referred to in Article 10 of the regulation (NFC+)
- Non-financial counterparties with aggregate positions in OTC derivatives subject to clearing under the clearing threshold referred to in Article 10 of the regulation (NFC-)
Clearing threshold
The clearing threshold is based on the gross notional value of the derivative contracts. If the financial and/or non-financial counterparties exceed the above-mentioned clearing threshold, clearing obligations come into effect in accordance with Article 4 of EMIR.
The clearing thresholds according to Article 10 of EMIR are further specified in delegated regulations and subject to continuous review by ESMA. They are as follows:
- EUR 1 billion in gross notional value for OTC credit derivative contracts and equity derivative contracts
- EUR 3 billion in gross notional value for OTC interest rate derivative contracts and foreign exchange derivative contracts
- EUR 4 billion in gross notional value for commodity derivatives
Clearing obligations
Central clearing is the procedure by which clearing is conducted with central counterparties, including calculations of net liabilities and ensuring that financial instruments, cash, or both, are available to hedge exposures arising from the derivatives. In a clearing, the central counterparty enters into an agreement between the counterparties becoming the buyer to every seller and the seller to every buyer.
The clearing obligation applies to all OTC derivative contracts belonging to the classes of OTC derivatives, which by definition are subject to the clearing obligation. ESMA is responsible for determining which classes of derivative contracts are subject to the clearing obligation.
OTC derivatives subject to the clearing obligation should be cleared in central counterparties that have been authorised (central counterparties within the EEA) or recognised by ESMA (central counterparties outside the EEA). More information about central counterparties can be found on the ESMA website .
Trade repositories
Trade repositories are central data centres that collect and maintain the records of derivatives. Read more about trade repositories on the ESMA website.
Reporting obligations
All derivative trading is subject to the reporting obligation and this means that the details of any derivative contract they have concluded and of any modification or termination of the contract are reported to a trade repository.
The information must be submitted to a trade repository which has been registered with (trade repositories within the EEA) or recognised by ESMA (trade repositories outside the EEA). The reporting obligation applies equally to financial counterparties and non-financial counterparties, regardless of the clearing threshold values (FC+, FC-, NFC+ and NFC-).
In the absence of a trade repository, the information should be submitted directly to ESMA.
Selection of derivative trade repositories
Reports may only be sent to a derivative trade repository that has been registered or recognised by ESMA. There are currently eight derivative trade repositories that have been approved and a list of them can be found on the website. Counterparties are responsible for selecting the trade repositories they choose to do business with. It should be noted that there are no trade repositories located in Iceland.
Risk mitigation requirements
EMIR requires that financial and non-financial counterparties meet risk mitigation requirements for all derivative contracts that have not been cleared by a central counterparty. Rigid requirements are placed on financial and non-financial counterparties with positions above the clearing thresholds specified in Article 10 EMIR (NFC+) but more lax requirements are placed on non-financial counterparties with positions below the aforementioned clearing thresholds values (NFC-).
They are:
- timely confirmation of the terms of the contract,
- portfolio reconciliation,
- portfolio compression
- analysis and resolution of disputes
- daily mark-to-market valuation of outstanding contracts,
- exchange of collateral,
- sufficient capital to manage risks not covered by exchange of collateral.
The table below lists the measures stipulated by EMIR to mitigate the risk of derivatives that are not centrally cleared and the different requirements placed on the various categories of counterparties.
MEASURES TO MITIGATE RISK | COUNTERPARTY CATEGORIES | ||
FC | NFC+ | NFC- | |
Booking of market value | Yes | Yes | No |
Timely confirmation | T+1 | T+2 | |
Reconciliation of portfolios | Daily, weekly or quarterly. Depending on the size of the portfolio. | Quarterly or annually. Depending on the size of the portfolio. | |
Portfolio compression | When counterparties have more than 500 outstanding derivative contracts with each other, they are obliged to identify the possibility of merging and reducing the number of outstanding contracts. | ||
Dispute resolution | A procedure must be in place and the Financial Supervisory Authority must be notified | Procedure must be in place. | |
Exchange of collateral | Yes | No |
Exemptions from the provisions of EMIR
Clearing obligation requirements do not apply to derivative transactions between counterparties within the same group, but subject to certain conditions. If counterparties within the same group are both legally established within the EEA, the Central Bank of Iceland must be notified of the exercising of this exemption 30 days before it is exercised. An authorisation to exercise the exemption is considered to be granted if no objection has been expressed by the Central Bank within 30 days of receiving the notification.
EMIR also grants exemption from clearing obligations between counterparties within the same group where one of them is established within the EEA and the other outside it. Under such circumstances, an authorisation to exercise the exemption must be sought from the Central Bank. The Central Bank must respond to such an application within 30 days of its receipt.
Exemption for intra-group OTC derivatives trading:
Exemptions from the obligation to notify a derivatives trade repository of derivatives trading between counterparties within the same group are granted when at least one of them is a non-financial counterparty; if they are both subject to adequate, centralised risk assessment, measurement and control processes and if the parent company is not a financial counterparty. The Central Bank of Iceland must be notified of the intention to exercise this exemption by e-mail to emir@sedlabanki.is
Exemptions from increased risk mitigation requirements, pursuant to Article 11 of EMIR, are granted subject to the fulfilment of special conditions specified in the same article. However, non-financial counterparties who intend to exercise such an exemption are required to notify the Central Bank of such intentions by e-mail to emir@sedlabanki.is
More information about EMIR
- ESMA website
- EU Commission website
- EMIR and central clearing of OTC derivatives (Icelandic)
An article by Hörður Tulinius, a specialist in On-Site Inspections and Securities, can be found in the August issue of the Financial Supervisory Authority’s 2015 financial affairs journal (Fjármál). - EMIR regulation and its impact on Iceland (Icelandic)
Slides from the presentation by specialist Andri Már Gunnarsson at the Financial Supervisory Authority’s breakfast meeting on 21 August 2015 - EMIR Regulation: What impact will the entry into force of the EMIR regulation have on Iceland? (Icelandic)
Article by Hörður Tulinius in Viðskiptablaðið on 28 September 2018 - Amendment to the Act on Derivatives Trading, Central Counterparties and Derivatives Trading Registries (Icelandic)
News on the Central Bank's website on 29 June 2021 - Circular regarding EMIR Refit (Icelandic)